What Are Structured Products?

Level 1: Beginner | Module 1.1 | Time: 2 hours

🎯 Learning Objectives

By the end of this module, you will:

• Understand the core concept of structured products
• Grasp the “LEGO blocks” analogy for building structures
• Learn why structured products exist and who uses them
• Identify the basic components (bonds + options)
• Debunk common misconceptions

Prerequisites: Introduction to Derivatives

Definition: What is a Structured Product?

A structured product is a pre-packaged investment strategy that combines multiple financial instruments to create a custom risk/return profile.

The Simple Version

Think of a structured product as a financial recipe:

Traditional Investing:
Buy Bitcoin → You own BTC → Profit/loss from price changes

Structured Product:
Own Bitcoin + Sell call options + Buy put options =
Custom payoff that fits YOUR specific goals

Key Insight: Instead of just buying/selling assets, you combine them to create exactly the risk/return profile you want.

The LEGO Blocks Analogy

Structured products are like LEGO:

Individual Blocks (Components)

1. The Asset (Underlying)

• Bitcoin, Ethereum, stocks, bonds
• The foundation

2. Call Options

• Right to buy at a price
• Add upside exposure

3. Put Options

• Right to sell at a price
• Add downside protection

4. Bonds (Zero-Coupon)

• Guaranteed payment at maturity
• Provides capital protection

Building with LEGO

Example 1: Capital Protection Structure

Component 1: Zero-coupon bond ($95,000 grows to $100,000 in 1 year)
Component 2: Call options on Bitcoin ($5,000 worth)

Result:
- Guaranteed $100,000 back (from bond)
- Participate in Bitcoin upside (from calls)
- Custom structure: "Protected upside"

Example 2: Income Generation Structure

Component 1: Own 1 Bitcoin ($50,000)
Component 2: Sell call option (+$2,500 income)

Result:
- Keep Bitcoin if price stays below strike
- Earn $2,500 premium
- Custom structure: "Enhanced yield"

The Power: Infinite combinations = infinite possible payoff profiles

Why Structured Products Exist

Problem: Traditional Investing is Limited

Traditional Options:

• Cash: Safe but loses to inflation
• Bonds: Low returns in current rates
• Stocks: All upside, all downside (symmetric)
• Crypto: Massive volatility, no income

What if you want:

• Upside participation WITHOUT downside risk?
• Income WITHOUT selling your assets?
• Reduced volatility WITHOUT missing rallies?
• Custom exposure that doesn’t exist as a single product?

Answer: Structured products!

The Value Proposition

1. Customization Match precise risk/return objectives

2. Capital Efficiency Achieve goals with less capital

3. Risk Management Define maximum loss upfront

4. Income Generation Create yield where none exists

5. Access Get exposure to strategies unavailable to retail investors

The Basic Components (Decomposition)

Every structured product can be decomposed into simpler building blocks.

Example: Principal Protected Note

What You See (The Package):

"Invest $100,000 in a 1-year Bitcoin Principal Protected Note
- 100% principal protection
- 70% upside participation
- 0% downside risk"

What It Actually Is (The Components):

Component 1: Zero-Coupon Bond
- Cost: ~$95,000
- Pays: $100,000 in 1 year
- Purpose: Guarantees your principal

Component 2: Call Options on Bitcoin
- Cost: ~$5,000
- Participation: 70% (less than 100% due to budget constraint)
- Purpose: Gives you upside

Total Cost: $100,000
Result: You get protection + upside exposure

Visual Decomposition:

Principal Protected Note

     ↓ Decompose ↓

┌─────────────────────────────┐
│  95% → Zero-Coupon Bond     │  Protects principal
│         ($95k → $100k)      │
└─────────────────────────────┘

┌─────────────────────────────┐
│   5% → Bitcoin Call Options │  Captures upside
│         (70% participation) │
└─────────────────────────────┘

Key Lesson: Structured products are transparent. You can always “reverse engineer” them to see what you’re really buying.

Who Uses Structured Products?

1. Retail Investors (You!)

Use Cases:

• Generate income from crypto holdings
• Protect against downside while keeping upside
• Get consistent returns in sideways markets

Example:

Sarah owns 5 BTC ($250,000)
She wants income but won't sell

Solution: Covered Call Strategy
- Keep her BTC
- Sell monthly calls
- Earn 3-5% per month
- Accept capped upside

2. High Net Worth Individuals

Use Cases:

• Tax-efficient strategies
• Concentrated stock position management
• Customized risk/return profiles

Example:

John has $10M in Tesla stock (from early employment)
Can't sell (tax reasons, believes in company)
Worried about volatility

Solution: Collar Strategy
- Keep Tesla shares
- Buy protective puts (insurance)
- Sell calls to finance puts (reduces cost)
- Reduces volatility, maintains exposure

3. Institutional Investors

Use Cases:

• Pension fund liability matching
• Enhanced yield for endowments
• Regulatory capital efficiency

Example:

Pension fund needs 5% annual return to meet obligations
Bonds paying 3%
Can't take full equity risk

Solution: Principal Protected Note
- 100% capital protection (meets regulatory requirements)
- 80% equity upside (achieves return target)
- Lower vol than 100% equity allocation

4. Corporations

Use Cases:

• Hedging commodity exposure
• FX risk management
• Balance sheet optimization

Example:

Airline needs to hedge jet fuel costs
Future prices uncertain

Solution: Custom collar on oil
- Cap max price paid (ceiling)
- Give up savings below floor (pay premium)
- Budget certainty for next year

Common Structured Product Types

1. Covered Calls / Cash-Secured Puts

Complexity: Low Goal: Income generation How: Own asset, sell options against it

2. Principal Protected Notes (PPN)

Complexity: Low-Medium Goal: Capital protection with upside How: Bond + call options

3. Range Accruals

Complexity: Medium Goal: Income from low volatility How: Earn yield when price stays in range

4. Autocallables

Complexity: Medium-High Goal: High coupons with early redemption How: Trigger levels, memory coupons

5. Barrier Options

Complexity: High Goal: Cheaper options with conditions How: Knock-in/knock-out features

6. Multi-Asset Structures

Complexity: High Goal: Diversification, correlation plays How: Multiple underlyings, best-of/worst-of

How Structured Products Work: The Process

Step 1: Identify Objective

Questions to Ask:

• What’s my view on the market? (bullish, bearish, neutral)
• What return do I need?
• How much risk can I tolerate?
• What’s my time horizon?

Step 2: Select Building Blocks

Based on your answers:

Bullish + Need income → Covered call Neutral + Want yield → Range accrual Bearish + Protect capital → Buy puts or protective collar Uncertain + Must protect principal → Principal protected note

Step 3: Combine Components

Example: You’re neutral on Bitcoin for next 30 days

Goal: Maximize income in sideways market

Structure:
1. Own 1 BTC at $50,000 (foundation)
2. Sell $55,000 call (collect $2,000 premium)
3. Sell $45,000 put (collect $1,800 premium)

Result: "Short Strangle" combined with ownership
- Collect $3,800 total premium (7.6% in 30 days!)
- Profit zone: $45,000 - $55,000
- Risk: If BTC breaks out of range, you have obligations

Step 4: Price and Risk Analysis

Calculate:

• Maximum profit
• Maximum loss
• Break-even points
• Probability of profit
• Greeks (Delta, Gamma, Theta, Vega)

Step 5: Execute and Monitor

Execution:

• Enter all legs simultaneously (reduces slippage)
• Use limit orders
• Check fills

Monitoring:

• Track P&L daily
• Adjust if market view changes
• Roll options if needed
• Close at target profit or stop loss

Traditional vs Structured Comparison

Advantages of Structured Products

1. Precise Risk/Return Profiles

Want exactly:
- 0% downside below $40k
- 80% upside above $50k
- Maximum $5,000 at risk

You can build this! Impossible with just buying/selling BTC.

2. Income in Any Market

Bull market → Sell calls (cap upside, earn premium)
Bear market → Sell puts (get paid to buy lower)
Sideways → Sell both (maximize premium collection)

3. Capital Efficiency

Traditional: Need $50,000 to buy 1 BTC

Structured:
- Buy $50,000 call for $3,000
- Control 1 BTC with $3,000
- Free up $47,000 for other investments

4. Customization

Match your EXACT needs:
- Retirement portfolio → focus on protection
- Young investor → leverage upside, defined risk
- Income seeker → maximize premium collection

Disadvantages and Risks

1. Complexity

Issue: Hard to understand what you own Mitigation: Always decompose, understand each piece

2. Liquidity

Issue: Can’t always sell structured products early Mitigation: Only invest capital you can lock up

3. Counterparty Risk

Issue: Issuer could default (especially with banks) Mitigation: Use reputable counterparties, understand credit risk

4. Opportunity Cost

Issue: Capped upside means you miss big rallies Mitigation: Accept trade-offs, match strategy to view

5. Fees

Issue: Some structured products have hidden fees Mitigation: Build your own when possible, understand all costs

Common Misconceptions Debunked

Myth 1: “Structured products are scams”

Reality: They’re tools. Some are mis-sold, but the instruments themselves are legitimate. DIY structures using options are fully transparent.

Myth 2: “Only institutions can use them”

Reality: Anyone with access to options markets can build structures. This platform democratizes access.

Myth 3: “They’re always better than traditional investing”

Reality: No. They solve specific problems. Simple buy-and-hold often beats complex strategies.

Myth 4: “Guaranteed returns”

Reality: No investment is guaranteed (except government bonds, and even those have inflation risk). “Principal protected” doesn’t mean “profit guaranteed”.

Myth 5: “Too risky for retail”

Reality: Covered calls (a structured product) are often LESS risky than owning the asset alone. It depends on the structure.

Myth 6: “Set and forget”

Reality: Most structures need monitoring and potential adjustments. Not passive investing.

Real-World Example: Bitcoin Covered Call

Let’s walk through a complete example:

Scenario

Date: Jan 1, 2025
You own: 1 Bitcoin at $50,000
View: Slightly bullish, but don't expect huge moves
Goal: Generate monthly income

Structure: 30-Day Covered Call

Step 1: Own the underlying
- Already own 1 BTC ($50,000)

Step 2: Sell a call option
- Strike: $55,000 (10% above current)
- Expiration: 30 days
- Premium collected: $2,500

Total investment: $50,000 (your BTC)
Income collected: $2,500 (5% yield in 30 days!)

Possible Outcomes

Outcome A: Bitcoin at $53,000 (30 days later)

- Call expires worthless (below $55k strike)
- You keep your BTC (now worth $53,000)
- You keep the $2,500 premium
- Total position: $53,000 + $2,500 = $55,500
- Gain: $5,500 on $50,000 (11% in 30 days)

Result: ✅ Perfect outcome

Outcome B: Bitcoin at $60,000 (30 days later)

- Call is exercised (above $55k strike)
- You must sell BTC at $55,000
- You keep the $2,500 premium
- Total proceeds: $55,000 + $2,500 = $57,500
- Gain: $7,500 on $50,000 (15% in 30 days)

BUT: You missed out on $60,000 - $57,500 = $2,500 extra upside

Result: ✅ Still profitable, but capped

Outcome C: Bitcoin at $45,000 (30 days later)

- Call expires worthless (below $55k strike)
- You keep your BTC (now worth $45,000)
- You keep the $2,500 premium
- Total position: $45,000 + $2,500 = $47,500
- Loss: $2,500 on $50,000 (5% loss)

Without covered call: Would have lost $5,000 (10% loss)
With covered call: Only lost $2,500 (5% loss)

Result: ⚠️ Loss reduced by premium

Key Insights

1. Income in sideways market (Outcome A)
2. Capped upside in rally (Outcome B)
3. Reduced loss in decline (Outcome C)
4. Trade-off: Accept limited upside for income and downside buffer

When to Use Structured Products

✅ Use When:

1. You have a specific market view

   • Not just “bullish” but “moderately bullish, expect 10-15% gain”

2. You want income from holdings

   • Instead of just holding, earn premiums

3. You need defined risk

   • Know your max loss before entering

4. Traditional products don’t fit

   • Need custom risk/return profile

5. You understand the components

   • Can decompose and price each piece

❌ Don’t Use When:

1. You don’t understand them

   • Complexity without understanding = danger

2. You’re very bullish/bearish with high conviction

   • Just buy/sell the asset, don’t cap yourself

3. You need liquidity

   • Can’t easily exit most structures early

4. You’re chasing yield blindly

   • High yield = high risk, always

5. Fees are unclear

   • Hidden costs destroy returns

Interactive Exercise: Build Your First Structure

Your Turn: Design a Structure

Scenario:

You own: 2 ETH at $3,000 each ($6,000 total)
View: Neutral for next 60 days, expect price between $2,800 - $3,200
Goal: Maximize income
Risk tolerance: Moderate

Question: What structure would you build?

Suggested Structure: Short Strangle

Component 1: Own 2 ETH ($6,000)

Component 2: Sell 2 call options
- Strike: $3,200 (top of expected range)
- Expiration: 60 days
- Premium: $150/each × 2 = $300

Component 3: Sell 2 put options
- Strike: $2,800 (bottom of expected range)
- Expiration: 60 days
- Premium: $120/each × 2 = $240

Total Income: $300 + $240 = $540 (9% yield in 60 days!)

Risk:
- If ETH > $3,200: Must sell at $3,200 (miss upside)
- If ETH < $2,800: Must buy more at $2,800 (okay if you want more exposure)
- Ideal: ETH stays $2,800-$3,200 → keep all premium + ETH

Why this works:
- Matches your neutral view
- Maximizes income in expected range
- Risk aligned with tolerance (you're okay accumulating more ETH)

Key Takeaways

1. Structured products combine simple instruments to create custom payoffs

• Like LEGO blocks → infinite combinations
• Always decomposable to understand components

2. They exist to solve specific investment problems

• Income generation, capital protection, customization
• Not always better, but sometimes perfect fit

3. Used by retail and institutional investors

• Democratized by options markets
• This platform makes them accessible

4. Trade-offs are inherent

• Cap upside → earn income
• Protect downside → reduce upside participation
• No free lunch

5. Understanding is critical

• Know what you own
• Decompose to individual components
• Calculate risk and return before entering

What’s Next?

You now understand what structured products are! You’ve learned:

• ✅ The core concept and LEGO analogy
• ✅ Why they exist and who uses them
• ✅ Basic components and decomposition
• ✅ Advantages and risks
• ✅ When to use them

Ready to build your first structure?

Continue to: Covered Calls →

This is the simplest and most popular structured product. Master this, and you’re on your way!

Additional Resources

Explore Further:

• Structure Tool - Build and price your own structures
• Case Studies - Real-world examples
• Glossary - Reference all terms

Practice:

• Decompose existing structured products
• Design structures for different market views
• Compare payoffs vs traditional investing

Next Module: Covered Calls →

Related Topics:

• Principal Protected Notes - Capital protection
• The Greeks - Understanding risk metrics
• Range Accruals - Advanced income strategies