More than $241 million of structured notes tied to Apple Inc. face losses after a 27 percent drop in the stock of the world’s most valuable company eroded built-in cushions that protect investors.
Banks issued 76 U.S. notes linked to Apple stock during the seven weeks starting Aug. 20 when the company was valued at $650 a share or more, according to data compiled by Bloomberg. Sixty-three percent of the securities absorb as much as 20 percent of stock price declines before investors are at risk of losing principal or coupon payments, Bloomberg data show.
Banks issued $1.66 billion of notes in the U.S. tied to Cupertino, California-based Apple this year, almost three times as many as the year-earlier period, making it the most popular underlying company, Bloomberg data show. Many of the securities are so-called reverse convertibles, notes that pay a high coupon while risking large losses if the share price plummets.
“If notes linked to Apple, especially reverse convertibles, were sold correctly, there’s almost no risk of investor confusion when the stock is down,” said John Tessar, senior vice president at JVB Financial Group LLC in Boca Raton, Florida. The products, which convert to Apple shares if the stock declines below the protection barrier, are sometimes marketed as appropriate for investors who wouldn’t mind owning the reference equity for the long term.
“With short-term investments like these, you would hope that the investor would hold onto the investment and receive the coupon unless their opinion of the stock has fundamentally changed,” he said.
JPMorgan Chase & Co. sold the largest security linked to Apple during the seven-week period, $65.5 million of one-year auto-callable notes on Aug. 30. Investors receive 13.56 percent annually every three months, as long as the share price of Apple is at least $531.25, or 80 percent of its initial value, with the entire investment at risk, according to a prospectus filed with the U.S. Securities and Exchange Commission. The note is redeemed automatically on certain dates if the stock has risen above its starting level.
In Nasdaq trading Friday, Apple shares sank 3.8 percent to end at $509.79. The stock reached a high this year of $702.10 on Sept. 19.
The note has traded below par since it was issued, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Investors exchanged the securities at 83.3 cents on the dollar on Dec. 12, the lowest price this year.
Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.
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