How An Exotic Investment Product Sold In Korea Could Create Havoc In The U.S. Options Market

Tracy Alloway (0:10)

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

Joe Weisenthal (0:15)

And I'm Joe Weisenthal.

Tracy Alloway (0:17)

Joe, do you know what a super lizard is?

Joe Weisenthal (0:21)

A what?

Tracy Alloway (0:23)

A super lizard.

Joe Weisenthal (0:26)

No, I have no idea, literally none.

Tracy Alloway (0:29)

Do you know what a flash lizard is?

Joe Weisenthal (0:31)

Nope.

Tracy Alloway (0:33)

A double chance?

Joe Weisenthal (0:34)

Were these animals that you encountered on your vacation? Like with these like new year, did you vacation somewhere exotic and see these lizards?

Tracy Alloway (0:43)

I did. Well, I was in Marrakesh and I did see some chameleons, but no, this actually has nothing to do with the animals. It has to do with one of my personal favorite financial topics.

Joe Weisenthal (0:58)

Okay, so what is a super lizard?

Tracy Alloway (1:00)

Super lizard.

Okay, so a super lizard or flash lizard or a double chance or any number of these interesting and exotic type names is actually a type of structured product known as an auto callable or an equity linked security and these are a type of product where investors basically buy an interest bearing note that's linked to a particular index like the Hang Seng or the Nikkei or something like that. Sometimes they're also linked to currencies. And they basically do it in order to make a profit. So they're sort of exotic structured products for retail investors and they come with these great names like Super or Flash Lizard.

Joe Weisenthal (1:47)

I am kind of aware of these things called structured products. I kind of get how they work, but I have to say I'm very excited that I'm, this is not an episode that I'm doing solo because I have a feeling this is going to be one of those ones where I sort of sit back and get in a question here or there, but mostly I just listen because this is tough stuff.

I think, right? It's complicated.

Tracy Alloway (2:15)

I think you're-

Joe Weisenthal (2:15)

I mean, literally just the way you're describing it.

I get it only because I've been doing some reading on these. I get what these notes are, but this is above my head.

Tracy Alloway (2:26)

I think you're underselling yourself, Joe, but I mean, the reason these structured products are pretty interesting is because you see them pop up every once in a while and usually not in a good way. So for instance, I think the most recent example was in 2018 You had a French bank, Netixis, that had a massive blow up because it was selling these structured products and had failed to hedge them properly or had gotten the hedge wrong. And then before that, I don't know if you remember, this was when I was in New York and actually sitting next to you, but in 2015, we had a big structured product blow up on a type of product known as a tarf, Target Redemption Forward, I think that's called, that was linked to the Chinese UN. And you remember China unexpectedly devalued the UN and it caused all sorts of turmoil in these structured products. I don't know if you remember, but I think I actually wrote a post at Bloomberg at the time that was called the tarf barf.

Not sure how I got away with that.

Joe Weisenthal (3:28)

That's a good one. But basically, the idea behind these structured notes and they're sold mostly to retail or high net worth investors is this idea that there's some underlying index, like you said, maybe the Hang Seng or maybe something in Europe or whatever, and someone will pay money, they'll buy one of these notes and get some sort of guaranteed return except if something happens, like maybe it goes down too much or whatever. And on the flip side, the bank has to buy or sell a bunch of derivatives to actually be able to deliver this guaranteed return. Is that kind of how it works?

Yeah.

Tracy Alloway (4:04)

And see, I knew you were under selling yourself before. I knew you've been studying that on this topic.

Joe Weisenthal (4:09)

No, but it's only because I've been cramming.

Tracy Alloway (4:11)

Okay, but the thing I was getting at is the reason they're interesting is because they pop up every once in a while. And as you mentioned, they're sort of linked to the wider financial system because when stuff starts to go wrong with them, you do get a wave of what's known as Delta hedging at the banks, at the issuing banks. And that can impact the market itself and you can sort of get a bad spiral. But we're gonna get into all of those details.