Single observation reverse convertibles pay a fixed positive return if the pre-specified trigger is not breached on the note’s final valuation date, and a lesser amount if the trigger is breached. Whereas basic reverse convertibles use the reference asset’s lowest value to determine if the trigger has been breached, single observation reverse convertibles use the reference asset’s value on the note’s final valuation date. All single observation reverse convertibles expose investors to the potential losses of the reference asset.
Single observation reverse convertibles cover a broad range of structured products. For example, some single observation reverse convertibles use coupon payments to compensate investors for bearing risk, while others use exposure to a limited portion of the reference asset’s capital appreciation.
Single observation reverse convertibles that pay coupons to compensate investors for bearing risk are quite similar to basic reverse convertibles. Neither type of reverse convertible offers exposure to the reference asset’s capital appreciation, and both expose investors to all of the reference asset’s capital depreciation if a trigger is breached.
The only difference is that basic reverse convertibles compare the reference asset’s lowest value to the trigger level, while single observation reverse convertibles compare the reference asset’s final value to the trigger level.
This type of single observation reverse convertibles includes Yield Optimization Notes with Contingent Protection and Buffered Reverse Convertible Notes. The maturity payoffs to these single observation reverse convertibles are similar to the payoffs of an unsecured coupon-bearing note combined with a contingent short put option on the reference asset.
Single observation reverse convertibles that use small exposure to the reference asset’s capital appreciation to compensate investors for the risk of loss have payoffs exactly like a zero-coupon, unsecured note issued by the brokerage firm and three options on the reference asset: a short put option, a long call option, and a short call option. This type of single observation reverse convertibles include some PLUS and Buffered PLUS, Buffered SuperTrack and Buffered iSuperTrack notes, Performance Securities with Contingent Protection, and Return Optimization Securities with Contingent Protection.
Table 2 lists a few of the single observation reverse convertibles which have been sold under different brand names by various brokerage firms.