According to the findings, guaranteed accumulators on stocks with low volatility and low forward prices should ideally knock out 104%-105%, or roughly the same level as regular accumulators, and at about 108% for stocks with high volatility and high forward prices. In practice, private banks tend to sell guaranteed accumulators with much lower knock-outs.
Investors in share accumulators buy a certain amount of stock at a fixed price each day the market price stays below a pre-agreed knock-out level. Regular accumulators typically knock out when the stock hits 105% of the launch price, which is fine when markets are doing a crab walk but these trades can easily knock out within a few days when markets are see-sawing.
Bankers came up with the idea of guaranteed accumulators û typically offering a minimum one-month of accumulation û to keep the trades alive for longer. The cost of the guarantee is much lower knock-outs, typically at about 102%. Even so, investors realise there are no free lunches and seem more than happy with this arrangement û by some estimates guaranteed accumulators now account for more than half of all structured product sales at private banks.
But according to RBS, these low knock-outs are not set at the optimum levels and can end up being very expensive for investors. "The attraction of low knock-outs is obvious for private bankers, but are they best for clients?" asks Garry Frenklah, head of non-Japan Asia private banking sales, equity derivatives and FX/precious metal derivatives at RBS.
The boffins at RBS ran Monte Carlo simulations on two sample stocks to work out the optimum knock-out levels for guaranteed accumulators: Apple to represent a volatile stock and HSBC to represent a stable one.
The conclusion was the same for both stocks: "Strike levels are massively higher, particularly for guaranteed accumulators, when the knock-out is 102%-103%," says the research.
For HSBC, investors would be buying the stock at 92.13% of the initial price at the optimum 105% knock-out level, which is 4.26% cheaper than on a 102% knock-out. Investors would get Apple stock at 81.71% of the initial price, which is 9.94% lower than for a 102% knock-out.
As RBS concludes: "These low strikes are expensive."