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The Rise and Fall of Apple Linked Structured Products

The Rise and Fall of Apple Linked Structured Products

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Published by calibrateconfidence
The Rise and Fall of Apple Linked Structured Products
The Rise and Fall of Apple Linked Structured Products

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Published by: calibrateconfidence on Jan 26, 2013
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10/29/2013

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The Rise and Fall of Apple-linked Structured Products
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The rise in Apple’s market capitalization in 2012 coincided with adramatic increase in single-observation reverse convertibles, reverseconvertibles and autocallable notes linked to Apple’s stock price. Thesenotes all transfer the downside risk of owning Apple to investors but capthe upside at somewhat more than corporate bond yields. Issuers useindividual stocks like Apple as the reference obligations for reverseconvertible structured products because investors underestimate the risk of losses when the individual stock’s price falls.The decline in Apple’s stock price from over $700 in September2012 to $450 in January 2013 has resulted in over one hundred milliondollars of losses in Apple-linked structured products. In this paper, wesummarize our published reports on over 650 Apple-linked structuredproducts and identify the impact of Apple’s recent stock price decline oninvestors in these structured products.
I.
 
Introduction
Reverse convertibles are short-term notes whose principal repayment is linked tothe performance of a stock or a group of stocks. If the underlying stock’s price fallsbelow a pre-specified level during the term of the note, investors may receivesubstantially less than the face value of the notes. Reverse convertibles tend to pay highercoupon rates than traditional notes because, in addition to the issuer’s credit risk, thenotes expose investors to the risk of a decline in the price of the reference security.SLCG’s database of Structured Products Research Reports includes reports onover 650 Apple-linked structured products including 294 products which have not yetmatured as of January 24, 2013. The aggregate market value of these 294 Apple-linkedproducts was $356,410,237 on January 23, 2013 and $310,270,641 on January 24, 2013.After the close on January 23, 2013, Apple announced disappointing earnings and itsstock price fell 12.45% on January 24, 2013. Investors in the 294 Apple-linked products
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© 2013 Securities Litigation and Consulting Group, Inc., 3998 Fair Ridge Drive, Suite 250, Fairfax, VA22033.www.slcg.com. The primary authors of this report are Geng Deng, Tim Dulaney, Craig McCannand Mike Yan. Dr. Deng can be reached atgengdeng@slcg.com, Dr. Dulaney can be reached attimdulaney@slcg.com, Dr. McCann can be reached at 703-246-9381 orcraigmccann@slcg.comand Dr. Yan can be reached atmikeyan@slcg.com.
 
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The Rise and Fall of Apple-linked Structured Products
 
we value on a daily basis lost $46,139,596, or 12.95%, in one day and have lost over $80million, or over 20%, since the products were issued. This dramatic event illustrates therisk of structured products linked to volatile individual stocks like Apple.Almost all the Apple-linked structured products are reverse convertibles. Issuerslike UBS, Barclays and JP Morgan issue reverse convertibles linked to volatile individualstocks rather than to less volatile stock indexes because investors underestimate thedownside risk in volatile stocks and are over-confident in stocks they believe willcontinue to increase in value. Investors’ underestimation of risk and overconfidence inlikely returns allow investment banks to pay investors below market compensation for thebanks’ credit risk and for the market of the embedded short put options.
II.
 
Apple’s Stock Price, Volatility and Structured Products Issuance
A.
 
Apple’s stock price and market capitalization increases.
Apple’s closing stock price increased 675%, from $90.75 on January 2, 2009 to$702.10 on September 19, 2012 but has since declined 36% to $450.50 on January 24,2013. Apple’s closing stock price since December 31, 2008
 
is plotted in Figure 1.
Figure 1: Apple’s Closing Stock Price, December 31, 2008 to January 24, 2013.
 
 
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Securities Litigation and Consulting Group, Inc. © 2013.
 
B.
 
Apple’s stock has become more volatile over time.
Reverse convertibles are short put options attached to unsecured notes. When aninvestor buys a reverse convertible from an investment bank like UBS, Barclays or JPMorgan, they are effectively selling the bank a put option on the referenced stock andposting the note’s purchase price as collateral to ensure the bank that the investor will payabove market prices for the referenced stock if its price drops below some thresholdprice. The put option investors sell to the investment bank is more valuable, the morevolatile the stock is expected to be during the term of the reverse convertible.Apple’s stock price has become more volatile relative to the broad market. SeeFigure 2. If the impact of Apple’s increased volatility on the value of the embedded putoptions is not understood by retail investors, investment banks will be able to make moremoney issuing Apple-linked structured products.
Figure 2: Apple’s Implied Volatility, December 31, 2011 to January 24, 2013.
 

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