Using equity derivatives

Equity investment

Equity markets have delivered healthy returns to investors for prolonged periods over the past 20 years or so (see charts below of FTSE100 between 1990 and 2008). However, there have been times when share prices have fallen sharply, resulting in substantial capital erosion for those who have committed funds to the market. The steep decline in global equity markets starting in 2001, for example, shocked many investors who had grown accustomed to capital growth throughout the sustained bull markets of the 1980s and 1990s, and many remain reluctant to re-enter the market.

Source: Bloomberg

Aversion to taking equity market risk, evident among some groups of investors, has been the main driver to the development of the multi-billion dollar market for capital protected equity products. Now investors ranging from small retail savers to large institutions can share in the benefits of rising equity markets without placing capital at risk.

Banks and financial institutions can now offer capital protection combined with potential to benefit from the positive performance of equities and/or equity market indices by using equity derivatives. Indeed, as a result of the flexibility of derivative instruments, any desired combination of risk and reward may be accommodated ranging from full capital at risk strategies with geared upside to more conservative products focusing on capital preservation.