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SLCG Research: Dual Directional Structured Products

Earlier this month, SLCG released a new research paper that values Dual Directional Structured Products (DDSPs). DDSPs are debt securities that feature payoffs very much like a long straddle position on the underlying asset for small price movements -- the investor realizes gains if the underlying asset increases or decreases in price (the origin of the term 'dual directional') within a certain range during the term of the note.

DDSPs differ from a conventional straddle position in a number of ways when the underlying asset's price changes more substantially. If the underlying asset depreciates below a barrier (or trigger) during the term of the DDSP, the investor has the potential to lose some or all of their investment. In addition, the potential return an investor can realize from the underlying asset appreciating in value is capped. See the following figure for a typical payoff at maturity.

A figure showing a line graph demonstrating a hypothetical dual directional's typical payoff at maturity.

While less than $20 million worth of DDSPs were issued in 2011, DDSPs have recently become a very popular structure for issuers with more than $250 million being issued in Q1 2012 alone. For a break-down of the DDSP total notional amount by issuer between January 2011 to May 2012, see the following figure.

A figure showing a pie graph demonstrating the total notional amount of dual directional structured products by issuer between January 2011 and May 2012.

DDSPs have recently garnered significant attention in the press. Bloomberg Structured Notes covered DDSPs in theirApril 26, 2012 brief. also recently featured a story covering these products.

We decomposed each structure product in our sample into an equivalent combination of options and then priced the options using conventional valuation techniques. Our research shows that, like most structured products, issuers charge investors substantial premiums to purchase these products. We also find that the DDSPs that offer investors leveraged exposure on the upside tend to be more overpriced than their unleveraged counterparts.