Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Lessons of 2008: Cheap Shares Ain't Cheap

By

Financial "innovations" dug us in deeper.

PrintPRINT
Equity markets fell significantly in 2008. The correction has brought with it problems for investors who used "accumulator" structures to purchase "cheap" shares, "cheap" currencies and "cheap" commodities. The structures are sold under various names. In financial markets, as everybody knows, there's little real innovation. But sales and structuring desks are pretty skilled in coming up with jazzy names and acronyms for even the most minor product idea or variation on an existing instrument.

The driver for the accumulator structures was the equity bull market -- especially Chinese stocks -- over the last few years. In this febrile environment, investors became keen to purchase "hot" Chinese stocks at prices that were below the market.

The typical accumulator contract entailed the investor entering into a commitment to purchase a fixed number of shares per day at a pre-agreed price (the "Accumulator Price"). The Accumulator Price was set (typically 10-20%) below the market price of the shares at the time the contract was entered into. The contract was for a fixed period, typically 3 to 12 months.

The contract was highly conditional. If the market price of the shares rose above a pre-specified level (the "Knock-Out Price"), then the obligation to purchase shares ceased. The Knock-Out Price typically was set (2% to 5%) above the market price of the shares at the time the contract was entered into. If the market price remained below the Knock-Out Price, then the investor obligation to purchase shares continued.

If the market price falls below the Accumulator Price (this would typically mean that the share price has fallen by at least 10-20% from the commencement of the contract) then the investor would be obligated to purchase shares. In most contracts, if the market price falls below the Accumulator Price, then the number of shares it's obligated to purchase would increase (this is known as the "Step Up" feature). For example, if the price fell below the Accumulator Price, then the number of shares that the investor is obligated to purchase might double. The typically Step Up was between 2 times to 5 times.

Accumulators involve the investor entering into a complex series of option contracts. The investor buys and sells a series of daily options.

A key feature of the product is the ability for investors to accumulate shares at the Accumulator Price that's set lower then the current price of the underlying shares. This key selling point of the structure is portrayed as the "discount" to the market price of the shares. The advantage is factually correct, but is a by-product of the economics of the option transactions entered into. It doesn't represent a financial benefit, or "discount," to the current market price of the shares being offered by dealer to the investor.

The structure of the accumulator dictates that the investor has limited capacity to gain, but risks large losses under certain circumstances.
< Previous
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

PrintPRINT
 
Featured Videos

WHAT'S POPULAR IN THE VILLE