Here’s What’s Happening With Those Korean Structured Notes That Bet Against Market Volatility

Joe Weisenthal (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

Tracy Alloway (0:16)

And I'm Tracy Alloway.

Joe Weisenthal (0:18)

Tracy, so you know what a sort of depressing phenomenon has been lately?

Tracy Alloway (0:23)

You're gonna have to narrow that down, Joe.

Joe Weisenthal (0:27)

Right, that's a very broad category. A very micro depressing phenomenon is that a lot of our recent episodes that we've done, which we sort of discussed in a very theoretical sense, have unfortunately started to become relevant extremely quickly.

Tracy Alloway (0:47)

Yeah, you're absolutely right.

One of the ones that springs to mind is the one we did with Claudia Somme back in, I think it was January or February about actually giving people money as a form of economic stimulus in order to stave off recession. And now we're sort of seeing that actually happen in the US, although obviously there are issues and a wider debate about the way that's currently being done.

Joe Weisenthal (1:12)

Yeah, absolutely.

Another one, and I would say this episode that we're going to do even more than any other, on Twitter several times a week, people ask for updates of it. So there's one in particular where I'm always getting tweets. It's like, hey, what's going on with what you talked about that one episode? I'm curious if you sort of have been getting the same one.

Tracy Alloway (1:36)

Yeah, I absolutely have. I know exactly what episode you were talking about, and it was a really good one.

It's Korean structured products. And not only have I been getting the same tweets with the same questions, and people asking for a general update and what's going on with the structured products, as well as the overall options market, but over in Asia, we've also been doing a few stories on it as well. And it turns out there's quite a lot that's been happening with these.

Joe Weisenthal (2:04)

Right, so for those who don't remember, in January, we recorded an episode about these Korean structured products, popular with retail investors, that were sort of premised on a, there essentially the payout was premised on a massive stock market crash not happening.

And as everybody knows, we've gotten this market crash. And so everybody has been saying, what's going on with those Korean structured products? When are you gonna do a follow-up? So today we're going to do a follow-up.

Tracy Alloway (2:33)

Great, I can't wait.

Joe Weisenthal (2:35)

Okay, so our guest back in January is the same guest we have today to do part two, is Benn Eifert. He is the CIO and founder of QVR Advisors.

Benn Eifert (2:48)

Benn, how are you doing?

So Tracy, hey, I'm doing well, thanks. It's great to be back.

Joe Weisenthal (2:55)

So I'll preface this by saying that I think anyone listening to this episode should go back and listen to the first interview that we did with you back in the middle of January so that we don't have to do a complete refresher of the Korean structured products. But just sort of give us the sort of the short version of the instruments that we were discussing and how their payout was linked to essentially stability in the market.

Benn Eifert (3:28)

Sure, so the very brief recap is, there are large global structured product businesses targeted primarily at retail and high net worth investors around the world, but very large in Korea in particular, also Japan to a somewhat lesser extent now.

And the most popular types of products in the recent market environment that we've had for the last decade or so where interest rates are very low, are essentially what are called reverse convertible, auto callable notes, which is a lot of words. But the idea is effectively, the retail investor is looking to generate a coupon. So a fixed income out of the equity market.

And the way that you do that in this environment is you sell some kind of optionality, right? And so these notes typically, the way they work is that the investor might get, let's say a 5% or a 7% annual coupon, unless or until one or more of, at least one of the underlying equity indices that the note is linked to is down by, let's say 30% or 40% at some point during the life of the note. And in that eventuality, at the point where that happens, the note is triggered into a knockout state and the investor loses that, say 30 or 40% of their investment. So the investor puts in $100, they're gonna get 107 back, unless the market's down. But if the market at some point is down, let's say 40% in one, in let's call it the Euro stocks or the Nikkei or the S&P, then the investor is actually just gonna take a 40% loss at that point.