FVC review: SG launches FTSE 100 product with defensive strike

Societe Generale has issued a leveraged return product tied to the FTSE 100 index. The product offers an upside participation rate of 500% in the underlying from a strike level of 90% – meaning the index can drop slightly from its spot level and still offer investors a return – subject to a maximum return of 56%.

The FTSE 100 will need to rise by 11.2% from its strike level in order for investors to achieve the maximum potential return. Any increases above this level will not be captured and passed on to investors. The product struck on January 15 and will mature on January 17, 2021 after a six-year term.

Investors' capital is at risk and is subject to a 60% European barrier. If the FTSE 100 is at between 60% and 90% of the strike level at expiry, investors will receive 100% of their capital investment back. But if the final level of the underlying is below the 60% barrier, investors will lose their capital at a rate of 1:1 – that is, 1% for every 1% fall in the index from the strike level. If the FTSE 100 has lost half its value at the time of the product's expiry, investors stand to lose 50% of their capital investment.

Any fluctuations in the value of the underlying during the product term will not affect the possibility of receiving capital investment at maturity as the index's level will only be measured at expiry.

Setting the strike level at 90% rather than 100% means investors will have a greater probability of capturing positive growth, and hence the maximum returns on offer. The maximum return is equivalent to an annually compounded return of 7.69% a year – significantly higher than the comparable risk-free rate in the UK, compensating investors for the credit risk and market risk this product will be subject to.

In theory, an investor who bought a product that struck on identical terms six years ago on January 13, 2010, with an expiry of January 13, 2016, would have achieved the maximum return of 56% – given a rise in the FTSE 100 of around 21%, from a strike set at 90% of its then-level of 5,473.48. That equates to more than double the 26.9% they would have made from a direct investment in the underlying, given an 8.9% growth in the FTSE 100 during that time plus an assumed dividend yield of 3% annually.

Pricing and risk

Using Future Value Consultants assumptions and parameters, this product has an overall score of 7.38 and a riskmap score of 4.13 – higher than some of the product's previous versions. This is most likely due to the increase in volatility in the FTSE 100, which through most of 2015 remained between 14% and 16%, before its gradual increase in recent months.

This product would be suitable for investors looking to capture enhanced returns in a moderately bullish scenario but with the comfort of limited capital protection. As returns are leveraged, it will outperform a direct investment in the underlying up to a growth level of 56%, excluding dividends. Above this level, investors would lose out on any potential growth. The product will return more than a direct holding in the FTSE 100, returning 5% for every 1% rise in the index.

Even in a slightly bearish scenario where the final level of the underlying falls below the initial level, investors would still achieve a return provided that, at maturity, the FTSE 100 closes at a level greater than 90% of its value on the strike date. This would not be possible if they had invested directly in the underlying, in which case they would face losses.

The main drawback of the product compared to a direct holding is the fact that returns are capped, but this is compensated for by the lower strike level and greater likelihood of achieving higher returns in a flat or falling market.

Like most structured products, there are three key components: a zero-coupon bond, a call spread that provides upside growth and a short put option which introduces capital risk.

The zero-coupon bond serves as the base payment of 100% and is used to provide investors' capital at maturity. The price of zero-coupon bonds will vary depending on interest rates and credit spreads. The rest of the money is used to buy a call spread and the short put option. For this product, the call spread will have a lower strike of 90% and an upper strike of 101.2%, with a gearing of 500%. On the downside, there is a short put option which sets the barrier level at 60%, with a downside gearing of 100%.

Future Value Consultants specialises in the design, pricing, risk management and analysis of structured products.

The information in this analysis is taken from sources which Future Value Consultants Limited deems reliable but no guarantee is made that the information is complete or accurate and it should not be relied upon as such. Any opinions in the analyses represent those of Future Value Consultants Limited at the time of writing but are subject to change. All valuations and prices shown are indicative only and do not imply an offer or commitment of any kind. The analysis does not constitute advice or recommendations nor should it be relied upon for any purpose. No liability whatsoever is accepted by Future Value Consultants Limited or Incisive Risk Information Limited for any loss or expense incurred from using this analysis.