Volatility & Structured Products

What Are Structured Products?

A structured product combines a bond with one or more embedded derivatives (usually options). The bond component provides capital protection or income, while the derivative component creates exposure to other assets or market conditions. In Germany, structured products are enormously popular with retail investors. The market for Zertifikate (certificates) exceeds €60 billion in outstanding volume.

Why Structured Products Exist

• Custom risk-return profiles – Tailor payoffs that don't exist in plain bonds
• Yield enhancement – Higher coupons in exchange for taking specific risks
• Capital protection – Participate in upside while limiting downside
• Access – Retail investors can gain exposure to complex strategies

Bond Volatility Basics

Volatility in fixed income refers to the magnitude of price fluctuations. Two types matter: • Interest rate volatility – How much rates themselves fluctuate (measured by swaption implied vol) • Credit spread volatility – How much spreads widen or tighten Higher volatility increases the value of embedded options, affecting the structured product's price and behavior.

The Greeks: From Equities to Fixed Income

The "Greeks" measure how a derivative's price responds to various factors. In fixed income, familiar concepts take new forms:

Greeks for Fixed Income

Vega: The Hidden Greek

For plain bonds, Vega is zero—there's no optionality. But structured products with embedded options have significant Vega exposure. Higher volatility → Embedded options worth more → Product price affected Example: A callable bond's issuer holds a call option. Higher vol makes that option more valuable to the issuer, making the bond worth less to you.

German Structured Products

The German Zertifikate market offers various structures. Understanding their Greek profiles helps assess risk:

Common German Structured Products

Aktienanleihe (Reverse Convertible)

Germany's most popular structured product. You receive: • Higher coupon than a comparable bond • At maturity: Either 100% cash OR shares (if stock fell below strike) You're essentially selling a put option. The "enhanced" coupon is your option premium. Your risk: receiving depreciated shares instead of cash.

Aktienanleihe Greeks

• Delta: Becomes negative as stock approaches strike (you're short the put)
• Gamma: Negative near strike – losses accelerate if stock drops through
• Vega: Short – higher volatility means higher probability of delivery
• Theta: Positive – time decay works in your favor (you sold the option)

Callable Bonds and Negative Convexity

A callable bond gives the issuer the right to redeem early (typically when rates fall). This embedded call option creates negative convexity: • When rates fall significantly, the bond gets called → you lose upside • When rates rise, you keep the bond → full downside exposure The asymmetry works against bondholders. You're compensated with a higher coupon (the option premium you receive).

Reading a Structured Product Term Sheet

• Underlying – What asset(s) drive the payoff?
• Strike/Barrier levels – Where does the payoff profile change?
• Participation rate – How much upside/downside do you capture?
• Capital protection – Is principal guaranteed? Under what conditions?
• Issuer credit risk – The product is only as safe as the issuer

Complexity Spectrum