An important discovery of modern finance is that a good source of crash insurance is retail investors who want yield. You can offer retail investors the following product:
They put $100 in a box for a year.
If the market crashes, you keep their money.
If the market doesn’t crash, you give them back $110.
This product is, roughly speaking, called a “put option,” though perhaps that is not obvious. More technically it is “a put option wrapped in a structured note.” The retail investor has sold you $100 of insurance against a market crash, and because you do not entirely trust the retail investor to be around in a market crash, you take the money up front. If the market crashes, you keep it. If the market doesn’t crash, you give the money back, plus $10, which you probably think of as “put premium” (insurance premium, the price you are paying for the put option) and which the retail investor probably thinks of as “interest” (yield, a nice 10% return on her money).
This solves the two problems of crash insurance supply. First, you have transformed the story from “you are selling me insurance against a market crash” (scary!) into “you are getting a high yield on your money” (everyone likes yield!). Second, you have taken the money up front, so you don’t have to rely on the credit of the put seller: If the market crashes, the money will be there.
And then, if you are a bank, you do two sides of the trade. On the one side, you buy puts from retail investors in the form of structured notes. On the other side, you sell puts to big investors who want protection against a stock market crash. The big investors want crash insurance, and you do not want to provide that insurance yourself, because you do not want to have a big loss when the market crashes. But you can source that insurance for them, from your retail clients.
In practice, banks do a slightly more sophisticated form of the trade:
The retail investor puts $100 in a box for a period of up to five years.
The retail investor gets paid, say, 10% a year ($10) in “interest” for each year her money is in the box.
If the market goes down by, say, 40% or more, the interest stops and the investor gets back $60 or less (that is, she experiences the full market losses: It’s as if she had put the $100 in stocks).
If the market goes up, then the trade ends after one year and the investor gets her money back (plus the 10% interest). (If the market is down, but by less than 40%, the trade stays on for up to five years.)
This product is called an “autocallable.” Here is a good 2022 FT Alphaville article by Russell Clark about “the mechanics and mayhem of autocallables”; he writes that “I like to think of autocallables as a distributed portfolio insurance market.” Big investors want insurance on their portfolios, and retail investors provide it.
I say “retail investors,” but that’s a little loose. You can’t just buy autocallables in your Robinhood account. In the US, at least, structured notes tend to be high-net-worth products; they are “sold, not bought” by brokers and financial advisers to wealthy customers.
But one long-term theme of this column is that, eventually, every possible trade will be packaged into an exchange-traded fund. The ETF is a perfect wrapper for retail-oriented stock trades. I wrote last year:
There are lots of trades that retail investors want to do, and/or that someone wants to market to them, and ETFs exist to package those trades into convenient formats. This can be helpful for brokers and advisers: Instead of coming to customers and saying “here’s a trade you can do,” explaining the trade in detail, and then working hard to execute the various legs of it, the brokers can go to customers and say “here’s a trade you can do in ETF format,” point the customers to the ETF’s disclosures to explain it, and then just buy the ETF to execute the trade. Everything is efficient and neatly packaged, so ...
좋은 글 감사드립니다. :)
