A structured financial product that offers investors a high coupon payment in exchange for taking on exposure to the price performance of an underlying asset, typically a stock or an index. In the crypto market, this derivative instrument is adapted to reference digital assets, allowing investors to earn enhanced yield with the risk of receiving the underlying crypto asset at maturity if its price falls below a specified barrier.
Mechanism
A reverse convertible consists of a zero-coupon bond and a short put option on the underlying asset. If the underlying asset’s price remains above the barrier level throughout the term, the investor receives the principal plus coupon. However, if the price drops below the barrier, the investor receives a predetermined number of units of the depreciated underlying asset instead of cash principal.
Methodology
Issuers structure these products to capitalize on an investor’s view of stable or moderately declining asset prices, generating income from the sale of the embedded put option. For crypto-linked reverse convertibles, risk management involves dynamic hedging strategies against the underlying digital asset’s volatility and managing counterparty risk, offering institutional investors a yield enhancement tool in a sideways or range-bound market.
An investor can hedge a crypto structured note by using options to neutralize the embedded derivative risks, thereby controlling portfolio outcomes with precision.
Issuers of crypto structured notes hedge their exposure by constructing and dynamically managing a precise, offsetting portfolio of derivatives to neutralize the market risks embedded in the products they sell.
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