Protect your investments
in a volatile market

Options are unique investment tools that seek to provide a level of certainty which is not possible with conventional investments. That’s because options have contractual features that provide a formulaic payment based on the performance of a reference asset, such as an index or ETF. The payment for options is dependent on the performance of the reference asset being above or below a predetermined price (strike price) on a specific date in the future (exercise date). The contractual nature of options makes them similar to personal property insurance contracts, as they make a payment on a future date that is contingent on an event taking place. There are two types of options: call options and put options.

A call option, for example on an index, gives the buyer the right to the upside of the index relative to a preset strike price on a specific expiry date in the future, in exchange for an upfront payment (premium). The call option buyer pays the premium up front and acquires the right to the index’s price appreciation above the strike price. The call option seller, on the other hand, gives up the right to the index’s future price appreciation above the strike price in exchange for upfront premium income. The value of the payment delivered is proportional to the magnitude by which the index price is above the strike price. Effectively, call options allow investors to trade in the potential future upside of an index.

A put option, for example on an index, gives the option buyer the right to profit from the decline of the index relative to a preset strike price on a specific future date, in exchange for an upfront premium payment. A put option buyer pays an upfront premium in exchange for the right to profit from the index’s decline below the strike price. A put option seller, on the other hand, gives up the right to profit from the index’s decline below the strike price in exchange for upfront premium income. Effectively, put options allow investors to trade in the potential future downside of an index.

The Buffer Protect Strategy utilizes a combination of call and put options (with an expiry corresponding to the Target Outcome Period) overlaid on an exposure to the reference asset. The overlay strategy has two components, as illustrated in the following example in which the reference asset is the S&P 500 and the buffer is 0 to -10%.

• Protection component: The strategy includes buying a put spread on the S&P 500 Index — a combination of buying a put option on the S&P 500 Index with a strike price that is close to the level of the S&P 500 Index, and selling a put option on the S&P 500 Index with a strike price that is approximately 10% lower than the level of the S&P 500 Index. The strategy must pay an upfront premium in exchange for the right to profit from the index’s decline between the level of the S&P 500 Index and approximately 10% lower than the level of the S&P 500 Index. This potential profit from the options overlay offsets the losses from the existing exposure to the S&P 500 Index and is what creates the buffer protect range of the Buffer Protect Strategy.
• Capped component: The strategy sells call options on the S&P 500 Index to give up the right to the index’s future price appreciation above the strike price, in exchange for upfront premium income. This is what creates the capped return range of the Buffer Protect Strategy. The strike price of the call options sold (and as a result the cap level) is set such that the premium paid for the protection component of the strategy equals the premium collected for the capped component of the strategy.

Some structured notes and buffer annuities provide targeted outcomes like the Buffer Protect Strategy but may come with unique risks; including concentrated credit risks, lack of transparency and lack of liquidity.

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