Losses magnified

PUBLISHED : Tuesday, 18 March, 2008, 12:00am
UPDATED : Tuesday, 18 March, 2008, 12:00am

There can be a big price to pay for derivatives contracts

A typical accumulator sold last year had an investment term of one year and was often linked to a single stock. These are often distributed as over-the-counter (OTC) derivatives contracts as opposed to structured notes. Many private banks have been selling these high-risk products to investors.

If the stock price increases by 3 to 5 per cent above the reference price, the investment can bring in a lot of cash. Therefore, in a bull market investors get to continuously roll over their positions, collecting large premiums at a fast rate.

But in a bear market, investors have to buy the shares if they fall under a set range, usually from 80 per cent to 90 per cent of the market price at the start of the contract.

Issuers of the products can sell shares to investors at a set price when the share prices have fallen. And due to the embedded triggers in these contracts, the amount of shares allocated to investors can be double. As these OTC contracts are settled daily, and are market-to-market, any position has to be settled in the form of discounted shares or investors have to meet margin calls on a daily basis.