Protection in plunging markets

You'll be devastated and some of you will promise yourselves never ever to be tempted into financial markets again. But it's not only this group who will suffer psychological problems; those who decide to keep trying will also be affected.

Confidence is something that is built very slowly over a period of time, but it only takes a second for it to be ripped apart. Lack of confidence can result in you entering the market at the wrong time or getting out too late. Lack of confidence can result in tunnel vision that detracts from open-mindedness, which is essential to knowing what is really happening.

Is there a solution? Fortunately, there are all kinds of so-called 'structured products' available worldwide. Structured products are usually created from standard, basic or original assets like stock and bonds, combined with derivatives like options and options-strategies. Structured products are offered by institutions such as banks.

Let's use a simple comparison as an example: the telephone. You have to know how to use it and what it can do for you; you don't have to know the technical ins and outs, that's the job of people in technical support.

In the same way, you only have to know how structured products can offer you what you need; the technicalities are done by the bank. They set up and create the product and they do the marketing and promotion.

Structured products can offer a solution. When I look at the Middle Eastern markets, I see a huge melt-down of stock prices. Who wants to sell now? Should you still be selling, or is this the perfect time to get in? Should you be buying as quickly as possible? So many questions! It would be so helpful if we had some sort of guarantee, and still be able to profit from the upside potential of the markets.

Well, how about a structured product as a guarantee product? How does it work? What's in it for you? A guarantee product can consist of many different instruments but the most basic and simple construction is this: a zero bond and call options, bought at the same time.

Example:

You have $1,000 to invest. Buy a zero bond (a bond with no interest payments) for $890 (89%), for example. The price of a zero is always below 100% because you will receive 100% at maturity and, because the issuer of the bond has to compensate you for this (but not by payment of interest), you are able to buy the bond for less than 100%.

You pay $890 and are guaranteed $1,000 at maturity. Your initial capital is guaranteed and, because you've only paid $890, there is still $110 of your initial $1,000 left for additional investments. With this amount you can, for instance, buy options.

A call option contract is a contract that affords the buyer the right to buy a specific underlying value (i.e. a certain stock index or basket of stocks) before a specific moment in time (maturity) at a price that has been agreed upon in the contract (strike price).

If the market goes up, the value of the options rises accordingly, therefore the right to buy at a fixed price becomes more interesting, especially if you can buy the underlying value at a strike price lower than the current market price (spot price).

So, if you buy a call option or multiple call options for $110, you will still profit from a bull market and you will have completed a guarantee product.

Too early

The only problem with such combinations is that options are not yet listed in Middle Eastern markets. It is too early for private investors to set up such a position, but banks do not need these listings at a regulated exchange as they can trade derivatives OTC (over the counter).

The banks are, therefore, already in a position to structure the products I have just described. When they do so, they can list them at an exchange and you will be able to invest in these instruments. Won't that be great?