Tuesday, 30 July 2024 Reading time : 2 minutes

The Reverse Convertible (RC) remains a popular yield enhancement product for investors who expect the underlying to move sideways or slightly higher. They give up the upside potential of their direct investment in exchange for a coupon. If the underlying closes at or above the strike at maturity, the RC buyer receives the nominal amount of the certificate plus the coupon (scenario 1). If the underlying closes below the strike, the investor receives the physical underlying (or the corresponding cash payment in the case of cash settlement) and the coupon (scenario 2). The coupon payment is therefore unconditional and, depending on the performance of the underlying, the investor will receive either a cash or a physical payment. 

The RC consists of two components: a short position in a put option on the underlying and a long position in a bond. When choosing the underlying and the maturity, it is important to understand the put option as well as the factors that influence its premium.

The put option gives the buyer the right to sell the underlying asset at a specified price (strike) on an agreed date (expiration date). At the same time, the counterparty (corresponds to the investor in the product in the case of RC), who thus holds a short position, agrees to buy the underlying asset at the strike price or to pay the difference between the current price and the strike price, depending on the structure of the put option, which is why physical delivery or cash settlement takes place in the second scenario. In return, the seller of the put receives a premium that is reflected in the coupon of the RC. The amount of the premium depends on five components:

1. Strike: The intrinsic value of an option (moneyness) is determined by the difference between the strike and the current price of the underlying asset. In the case of an RC, the strike is typically set at the money, i.e., the strike is equal to the price at the time the option is set. If the strike is set lower, the option is in the money. This increases the risk to the seller, for which he will demand a higher premium.
2. Time value: The time value of an option is the premium received for the remaining time until the option expires. As the expiry date approaches, the time value of the put option falls, which is advantageous for the short position.
3. Risk-free interest rate: According to macroeconomic theory, the risk-free interest rate influences the share price - if the interest rate rises, the share price also rises. If the market expects interest rates to rise, the premium for a put option usually decreases.
4. Implied volatility: Another external component that affects the option premium is the implied volatility. This is the market's view of the probability of future changes in the underlying asset. Unlike historical volatility, which is based on past price performance, implied volatility reflects expected fluctuations in the strike due to supply and demand. An RC will therefore generally offer a higher coupon if it was issued with high implied volatility. However, this also gives rise to an important aspect every investor should consider before buying - a high coupon also means an increased risk that the underlying asset will fall below the strike price, possibly resulting in a loss for the investor.
5. Dividends: The expected performance of the underlying also affects the premium of the put. For example, if a dividend is distributed during the term, the share price will normally fall by the value of the dividend after the distribution. This also increases the option premium.

The following Reverse Convertibles are on stocks that are not expected to pay dividends and have high implied volatility. The products have a maturity of three months and offer an interesting opportunity to generate an attractive coupon over a short period of time.

21.5% p.a. Reverse Convertible on Richemont

22.40% p.a Reverse Convertible on Logitech

16.80% p.a. Reverse Convertible on Siemens

23.00% p.a Reverse Convertible on Infineon Technologies

21.60% p.a Reverse Convertible on Alphabet

26.40% p.a. Reverse Convertible on Netflix

29.70% p.a Reverse Convertible on Spotify

Indicative terms

Disclaimer
This communication is for marketing purposes. It is neither an offer nor an invitation to submit an offer, to purchase or to subscribe to securities and does not constitute investment advice. You should consult your advisors before making an investment decision. Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause the actual results, financial condition, development or performance of the issuer to be materially different from any future results, financial condition, development or performance expressed or implied by such statements.
The present document has not been drawn up by the research department as defined in the rules of the “Directives on the Independence of Financial Research” published by the Swiss Bankers Association, hence these rules do not apply to this document. If securities are mentioned in the communication, the base prospectus, the final terms and any key information document may be obtained free of charge from Zürcher Kantonalbank, Bahnhofstrasse 9, 8001 Zurich, VRIS, and from www.zkb.ch/finanzinformationen.