# Forget tracker bonds - Do one yourself



## marathonic (14 Mar 2011)

Why give the banks/insurance companies more profits/commissions? Instead you can go the direct route via an execution only broker on the stock/options exchange.

Buy a December 2013 SPY Call Option at a $130 strike (the index is currently trading at $130.84) for $1,545. This gives you the option, but not obligation, to buy 100 SPY shares at $130 ($13,000 total) - even if it's then trading at, for example, $200.
Put $12,000 in National Solidarity Bond (4 Year)
Total Investment: $13,545.

Total Returned from National Solidarity Bond after tax is $13,696.28.

You've got 96% of your initial investment exposed to the stock market until December 2013 (2 years, 9 months) and your returns are uncapped. You will get a little more than your entire initial investement back after the four years and will be able to cash out any investment returns in December 2013.
If the S&P 500 grows at 10% p/a for the 2 years and 9 months, you'll get $4,019 in profit after the 2 years and 9 months followed by $13,696.28 back from the Bond after 4 years - a total of $17,715 (a 30% return with no intial capital at risk).

The bank/insurance company bonds add too many levels of complication regarding averaging for a certain period of time and/or having different levels of exposure to the markets at certain times. 

The direct method is much easier to understand.


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## LDFerguson (14 Mar 2011)

Thanks for this marathonic.  I'd heard various people (including Brendan Burgess) suggesting that a DIY tracker bond would be better than one offered by the banks or life assurance companies but I'd never seen a practical example of how it might work.  It makes sense to me that it should be more cost-effective if you strip out a sales commission in the middle.  

As someone who has worked with pooled funds all my adult life, I know little about the practicalities of buying options.  I presume that any stockbroker or online trading platform can accomodate them.  

What are the Irish tax implications of buying an option?

Do there tend to be minimum amounts?  Charges?

I see you've used the example of a December 2013 SPY Call Option.  Is there any online resource where you can view other options currently available, current trading price etc.?

Cheers, Liam


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## Duke of Marmalade (14 Mar 2011)

marathonic said:


> The bank/insurance company bonds add too many levels of complication...
> The direct method is much easier to understand.


I don't think so  The DIY version seems a bit of a mish mash with its different maturity dates.

But let's consider value for money.  For this we analyse the anatomy of the arrangement.

1)  Return on the cash element.  The National Solidarity Bond pays 3.31% AER.  The Tracker deposit element pays 6% p.a.  Remember this is effectively gross as because of the package you only pay tax whenever there is an overall return, i.e. on the option part.  Taking a 50/50 mixture of the Tracker options (so as to get an average 4 year term), it costs 79% to secure your money back with the Tracker.  With the NSB the equivalent is 87.8%.  So the Tracker is a massive 8.8% ahead on this count.

2)  The Options cannot be compared directly but it is reasonable to assume that the market values are a fair comparison here so we do not need to agonise about comparing their respective merits i.e. choice of index, currency risk, averaging, duration etc.

3)  The real question is which has the higher net charges.  The Tracker disclosure states its gross charges to be 8.8%.  But, coincidentally, this is cancelled by the interest subsidy in (1) above.  

So for the DIY version to equal the Tracker package in terms of value for money it would need Zero charges.  You are not telling me that a stockbroker would sell €1,500 Option at no charge, are you?


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## marathonic (14 Mar 2011)

Duke of Marmalade said:


> I don't think so The DIY version seems a bit of a mish mash with its different maturity dates.
> 
> But let's consider value for money. For this we analyse the anatomy of the arrangement.


 
It sounds like you're talking about the Irish Life Clear Tracker Bond. The first thing worth noting is that, because this plan is a life-assurance contract, it does not qualify for the Irish Deposit Protection Scheme. They also take a 1% government levy out of your initial investment.

The Irish Life product shows charges of 1,728 or 1,784 depending on the option. This is 8.514% - 8.92% in charges. 

It shouldn't matter what percentage is invested in the Bond and what is invested in the Option - or, similarily, what the APR on the Bond is. All that matters is that you get your initial investment back at the end of 4 years - after tax, if any, is deducted. Both options provide this.

With my option, the Call Option that you buy is already In-The-Money by $84 , you receive an extra $151 over your initial investment at the end of the 4-years and you don't pay the initial 1% government levy. Regarding charges, my stockbroker (Interactive Brokers) charges me $1.20 for buying an Option.

Also, with my option, there is no complex 'averaging' or no need to contact Irish Life anytime you want to know the value - you can just check Google for the quote for SPY.

As well as that, you get to withdraw any investment returns after 2 years and 9 months. This could be an advantage or disadvantage depending on what the market does but I like the idea of getting SOME of my investment back quicker.

Finally, although the National Solidarity Bond is locked in for the 4 year term, the Option isn't. You own this and can sell it at any time. If, for example, you had entered into this in March 2009, you could have sold the Option for a good profit in March 2010. The index rose by 65% or so during this time (I'm not saying this will happen again, but it's a possibility). If it did happen, the SPY would be valued at about $216 meaning your $130 call Option would be worth $8,600 + the time premium left in the Option (which should be around $1,600 with 1 year 9 months to expiration). We'll assume a time premium of $1,400 to give a nice round figure of $10,000.

This means that, if history were to repeat itself, you could withdraw $10,000 of your initial $13,545 investment after a year. Then you'd get your $13,696.28 (after tax) after the 4th year from the Bond. This would give you a return of $10,151.28 (less the tax due on the $10,000 that you withdrew on year 1).

In my opinion, the flexibility of the direct option over the Irish Life option makes it a no brainer - especially if you're investing a large amount.


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## Duke of Marmalade (14 Mar 2011)

_marathonic _I had a look at that IB website. Looks interesting, is it a hassle to sign up? Are they trustworthy? Are the costs really as low as you say? 

I have a number of comments re your last post.

1% Levy; yes that is a negative for the life assurance product.

I was overstating the tax advantage of the life asurance packaged product. Yes you do in effect earn gross interest on the deposit part of the package but in favour of the DIY version you only pay CGT on the excess of the Option payout over its cost (am I correct in that?). 

In fact, if the Option is subject to CGT (?) this could be an advantage for the many of us nursing losses on bank shares.

Most of your other points are well made, though the fact that the Option strike is currently ITM is a bit of a red herring as you will pay for that. Also I think averaging has some psychological benefits for punters which compensates for the complexity.


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## ronaldo (14 Mar 2011)

Duke of Marmalade said:


> _marathonic _I had a look at that IB website. Looks interesting, is it a hassle to sign up? Are they trustworthy? Are the costs really as low as you say?
> 
> I have a number of comments re your last post.
> 
> ...


 

Interactive Brokers users' accounts are insured by a third party so for you to lose your money, both IB and the insurance company would need to go bust at the same time. Here's my review of IB http://www.askaboutmoney.com/showthread.php?t=97602&highlight=interactive

Regarding the tax situation, I've always had a hard time getting accurate information about this online or from the Revenue. Most online information is regarding options granted by your company as part of your salary - which I believe is treated as income.

For normal Options traded on an exchange, I believe that CGT will apply. After all, when the Options reach expiry, all you're really doing is buying the shares at the Option strike ($130 in this case). You can then sell them at the market value. This means that, for example, if SPY was trading at $200, I'd consider it as $70 per share in CGT less the trading costs. With trading costs, I'd include the commissions as well as the option premium. I'm not sure if this is 100% correct but it's the best information I was able to find.


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## Brendan Burgess (15 Jul 2011)

I gather from speaking to people in the business that the only products selling at the moment are tracker bonds. 

I think this DIY approach is much better. Has anyone actually done it? Or is it a case of, if someone is smart enough to do a tracker bond, they would not invest in one?


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## Marc (15 Jul 2011)

[FONT=&quot]In recent years, structured products have gained favour among retail investors in Europe and the US. Investment banks promote these securities as sophisticated tools to help investors manage downside risk, enhance returns, or achieve other investment objectives.[/FONT]
[FONT=&quot]
[/FONT][FONT=&quot]Sales have grown briskly since 2006, and despite a decline after the 2008 market crisis, some industry sources expect a rebound in sales and a flurry of new products in the future.1 With this in mind, it may be useful to understand how the products work and to evaluate the costs, benefits, and tradeoffs before considering one in your investment strategy.[/FONT][FONT=&quot]
[/FONT]
*[FONT=&quot]Basic design[/FONT]*
[FONT=&quot]A structured product is a contract that promises to pay a future amount based on the performance of an underlying asset, such as a stock, market index, or commodity. The payoff is typically linked to a preset formula. Most structured products are designed to either preserve capital or enhance returns, and are typically issued as notes.2 The notes offer a specific payout over a designated period or at maturity, and the final payout depends on the performance of the underlying asset as well as the value of the derivatives written on it. Since the product typically is issued by an investment bank, the investor is exposed to the credit risk of that entity.[/FONT]

[FONT=&quot]One common product, a principal-protected note, generally offers a minimum return equal to the original investment, plus a potential return tied to performance of an underlying asset, such as a stock market index. If the index drops during the term, the investor gets his money back, but if the index rises, he may receive the upside gain, but usually only a part of the underlying asset's gain. Structured products can be replicated by portfolios composed of an interest-bearing instrument, such as a certificate of deposit or zero-coupon bond, equity securities, and options or other derivative securities whose performance is linked to the underlying index.3[/FONT]

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*[FONT=&quot]Complex design[/FONT]*[FONT=&quot]: Most   products have a complex design, which can make analysis of pricing, risk   exposure, and potential outcomes more difficult. Some investors equate this   complexity with higher potential returns, when, in fact, it may only mask   high fees and risk. Worse yet, investors may not understand the range of   possible outcomes. During the 2008 market crisis, some investors learned a   hard lesson when the issuing firm went bankrupt or when their structured   product experienced losses from poor performance of the underlying asset.[/FONT]

*[FONT=&quot]Substantial cost[/FONT]*[FONT=&quot]:   These products tend to carry a significant markup and costs that in some   cases are difficult to quantify, especially if an investor lacks the   technical knowledge to analyze the underlying components of the strategy.[/FONT]

*[FONT=&quot]Replication[/FONT]*[FONT=&quot]: The   payoff of virtually any structured product can be replicated in a portfolio   by holding the underlying securities, then buying or selling derivatives   written on those securities. In many cases, the costs associated with the   replication portfolio are much lower than the structured product itself.[/FONT]

*[FONT=&quot]Tradeoffs[/FONT]*[FONT=&quot]: In return for receiving a prescribed payout,   investors must accept a tradeoff in the form of a lower return and/or limited   upside potential. When evaluating a structured payout, remember that there is   no free lunch in the risk-return tradeoff. To pursue higher expected returns,   you must accept more risk. If you do not want to bear the risk, you must   transfer it to other investors and pay them for taking it.[/FONT]

*[FONT=&quot]Multiple Risks[/FONT]*[FONT=&quot]: First, there   are the inherent risks of the underlying security (e.g., the stock or index).   Investors also are exposed to credit risk of the issuing firm. The contract   is an agreement with the issuer to make a pre-determined payment in the   future, and thus, it is contingent on the firm being able to deliver.   Liquidity risk is another issue. Although many structured products are listed   and traded on exchanges, they may be difficult to sell, especially in a   volatile market. To avoid a potential liquidity problem, investors should   consider the time horizon of the product and attempt to match its maturity to   their anticipated financial need or objective.[/FONT]

*[FONT=&quot]Tax considerations[/FONT]*[FONT=&quot]:   It is also important to check tax consequences. Some instruments may have   certain appeal under the current tax rule. But, often, tax consequences   differ according to the investment situation (e.g., whether one buys at the   issuance or in the secondary market).[/FONT]

*[FONT=&quot]Who might benefit?[/FONT]*
[FONT=&quot]A structured product might help an investor who needs a specific payout at a designated point in the future and who is willing to pay another party to shoulder much of the uncertainty. But this benefit generally comes at the expense of lower yield or limited upside potential.[/FONT]
[FONT=&quot]
[/FONT][FONT=&quot]One example may be an individual who currently holds restricted company stock whose value may account for a significant portion of his total wealth. Although he might prefer to diversify this exposure, company rules may prohibit a sale until some future date. A structured product might provide protection against the downside risk of the company's stock (even though this might mean giving up the upside potential of the stock), and at the same time, provide better-diversified exposure to an equity index, such as the S&P 500.[/FONT]
[FONT=&quot]
[/FONT][FONT=&quot]Perhaps most important, investors who are considering a structured product should consider why they even need a highly structured payoff in the future—and if so, whether the payoff can be structured by other means in the portfolio. In many cases, the strategy can be replicated at a lower cost, and perhaps with less risk. Many investors would prefer an alternative that is less complex and more transparent. And as the recent credit crisis taught many investors, it is wise to avoid investing in things you do not understand.[/FONT]

"Never invest in anything you can't illustrate with a crayon" Legendary Fidelity Fund Manager, Peter Lynch.

[FONT=&quot]1[/FONT][FONT=&quot]. Larry Light, “Twice Shy on Structured Products?” _Wall Street Journal_, May 28, 2009.[/FONT]
[FONT=&quot]2[/FONT][FONT=&quot]. A reverse convertible bond is one example of a yield enhancement tool. It pays investors a higher coupon rate than other comparable bonds due to its higher risk. This risk comes in the form of the issuer having the option to pay off the debt with either cash or a predetermined number of common stock shares. The method of payment at time of maturity will depend on the stock price, and the issuer will pay with common stock when it is advantageous to do so. The reverse convertible bond was popular until the last market crisis, when many investors experienced heavy losses when they were paid off with lower-value stock shares.[/FONT]
[FONT=&quot]3[/FONT][FONT=&quot]. A call option provides the holder the right to buy the underlying security at a given price at a certain time in the future. A put option provides the holder with rights to sell the underlying security at a pre-specified price on maturity date. (American-style options can be exercised before the maturity date, whereas European-style options can be exercised only on the maturity date.) An option holder will exercise the put or call option only if the payoff is positive.[/FONT]


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## marathonic (10 Mar 2013)

marathonic said:


> Buy a December 2013 SPY Call Option at a $130 strike (the index is currently trading at $130.84) for $1,545. This gives you the option, but not obligation, to buy 100 SPY shares at $130 ($13,000 total) - even if it's then trading at, for example, $200.
> Put $12,000 in National Solidarity Bond (4 Year)
> Total Investment: $13,545.
> 
> ...



Okay, time for a review I think.

The tracker method gives 74% of growth and 100% of capital is protected.

The direct method gives 96% of growth and a little over 100% protection.

As of the initial post in this thread, SPY stood at $130.84 and a December 2013 SPY Call Option at a $130 strike costed $1,545.

That was 2 years ago which means your money is tied in for another 1.5 years with the Irish Life Tracker Bond.

With the direct route, your National Solidarity Bond return of $13,696 is tied in for another 2 years.


SPY has grown by $24.60 to $155.44. 

*Irish Life Tracker Bond*
That means that your original investment of $13,545 would be worth $15,429 now and none of it can be accessed for 1.5 years - but you get 74% of further growth until then.

*Direct Route*
The National Solidarity Bond would pay you $13,696 in 2 years time. You get 96% of further growth until the end of this year. 

A further option would be to just sell your December 2013 SPY Call Option at a $130 strike now for about $2,836 - leaving the Solidarity Bond in place to mature.


Assuming a flat market from now until maturity, you'd have a total return of $15,429 from the Irish Life product with no access for another 1.5 years.

You could have $2,836 now with the direct method and a further $13,696 in 2 years - giving a total of $16,532 (+ whatever interest you happen to get, or save, by having some access now).


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## Rory Gillen (25 Mar 2013)

The direct route assumes you understand these things, but on most occassions it is surely obvious that, with lower costs, the direct route is highly likely to produce the best returns. 

The Irish banks are still repairing their balance sheets and for as long as they are desperate for your deposits they are paying up for 'sizeable' medium-term deposit flows. For this reason, and this reason alone, structured guaranteed products are still quite competitive vis-a-vis a DIY approach. For all other times, structured products are a waste of time for the investor and serve only to remunerate the intermediary.


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