What’s Ahead:
- Structured Note Payoffs can potentially enhance market gains
- Hard Protection can add an extra level of downside risk mitigation
- Hard Protection may be available at various levels
If you’ve heard of Structured Notes but aren’t quite sure what they are or how they work, this brief is for you. It explains how Hard or Buffer Protection, one type of Structured Note protection, can eliminate or decrease the negative return of the investment in volatile market conditions.
Here are the basics: Structured Notes are like a hybrid between a stock and a bond. Although they are technically bonds, their market value typically derives from the return of a stock or index, called the Underlier. The Structured Note has performance terms that adjust the return of the Underlier to determine the Structured Note’s return. Those adjustments are commonly in the form of protection against negative returns and enhancement of positive returns.
A Structured Note, technically a fixed-income instrument, acts like a hybrid between a stock and a bond, while its overall performance is based on the returns of an underlying asset. A Note’s payoff profile and its protection levels are customized to the advisor’s preference for their clients. There are two types of protection levels: hard (buffer) and soft (barrier). This brief delves into the characteristics of hard protection and how varying levels of this protection type can eliminate or decrease the negative return of the underlying asset in certain market conditions.
Hard protection is the more conservative of the two protection types. In general, it offers a “buffer” against market declines, meaning the investor does not incur losses until the protection level on the underlier is breached.
Hard Protection Specifics
Hard Protection insulates against market risk by absorbing some or all of the Structured Note’s negative return. Here’s how it works: Hard Protection modifies the return of the Underlier on the maturity date of the Structured Note.
When the Structured Note’s negative return is between 0% and the protection level, Hard Protection absorbs the Underlier’s negative return completely, resulting in a 0% return for the Note. In other words, the Structured Note fully absorbs the Underlier’s negative return. However, when the Underlier’s negative return is below the protection level, the Note’s loss is decreased by the protection amount.
The table below shows how Hard Protection modifies the Underlier’s return:
| Underlier Return | Note Return |
|---|---|
| 0% to Protection Level | 0% |
| Below Protection Level | Underlier Return + Protection Amount |
The following chart can be used to show how Hard Protection may adjust the Underlier return across multiple market environments.
Hard Protection may be a good option if you want to eliminate or significantly decrease an asset’s negative return in moderate to severely volatile market conditions. It’s most effective in negative scenarios with significant volatility. For more information on choosing note types, we recommend reading our “Choosing a Protection Type” guide.
By understanding how Hard Protection works, you can potentially mitigate your risk in uncertain market conditions, and produce a greater return on your investment than holding the Structured Note in the traditional way.
Structured Notes have complex features and may not be suitable for all investors. They are sold only by prospectus and investors should read the prospectus and pricing supplement carefully before investing as they contain a detailed explanation of the risks, tax treatment, and other relevant information about the investment. The tax treatment of structured notes varies depending on the offering, and can be uncertain in some cases. Structured products are sold through financial professionals, and investors should consult their accounting, legal, and/or tax professional before investing.
US127/1.0/2308
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