Structured Products

Bonus certificates are participation products that feature full upside participation and a conditional capital protection as long as the underlying asset doesn’t cross a predefined threshold (barrier).

In most products, a fixed “bonus” will be paid to the holder of the certificate if the underlying asset didn’t cross the preset barrier and if the performance of the underlying asset is lower than the predefined bonus.

Hence, bonus certificates tend to perform well in both sideways and rising markets. There are however two major disadvantages of the product: first, bonus certificates do not pay out any dividends, which stock shareholders get on a yearly or quarterly basis. Second, the payoff shown below is only valid at maturity; the mark-to-market price of the bonus certificate during its lifetime differs strongly from its final payoff. It may be stated that in general, the contingent protection and bonus will only “grip” after most of the product’s maturity has elapsed.

Payoff Features

Bonus certificates are constructed by means of a zero-strike call (i.e. a certificate) and a long down&out put option. The zero-strike call provides the participation (both to the upside and the downside), and the down&out put option generates the barrier and the bonus. More precisely, the strike of the down&out put option determines the level of the bonus and the out-strike determines the level of the barrier. In case of stocks, the dividends are used to buy the down&out option. Therefore, higher implied (future) dividends generate a higher bonus level, a greater contingent protection level or a mix of both.

Consider the following bonus certificate example:

• Stock: BASF, dividend yield of 5.5%
• Maturity of the product: 2.5 years (includes 3 yearly dividends)
• Bonus: 20%
• Protection: 50% (knock-out strike at 50% of spot price)
• Initial price: 100% of spot

A person wishing to invest in BASF stock could consider buying the bonus certificate mentioned in the example instead. It depends on his view of the stock's future price evolution, his risk profile and the current market conditions;

• Is the investment horizon of the investor about equal to the bonus certificate's? Clearly, the certificate is not suited for short term in and out trading.
• Is the volatility forecast favorable? A rising volatility after the product has been bought is generally not favorable forthe mark-to-market of the product.
• Is the investor ready to forgo 3 dividends? After all, they are expected to amount to 16.5%, not a negligible number. The bonus amounts to 20%, but if the barrier is breached, the bonus disappears.

Do’s

• Do invest in bonus certificates when the volatility is high, or expected to fall.
• Do invest in bonus certificates when the skew is high or expected to fall.
• Do invest in bonus certificates when the dividend yield of the underlying stock or index is high or expected to fall.
• Do favor a better contingent protection over a higher bonus.
• Do favor a shorter time to maturity over a higher bonus level or a better contingent protection.
• Evaluate the benefits versus the costs of a European style down&out barrier. Usually, bonus certificates have an American Style barrier that can be knocked out anytime, even intraday. It may be worthwhile to choose a European style barrier, which can only be knocked-out at maturity. Or try a window barrier, which can be knocked out only during a certain time window within the lifetime of the product, say the last 3 months, which may be of advantage if the cost is not too high.
• In some jurisdictions, it is possible to optimize your after-tax returns with Bonus Certificates.

Don’ts

• Don't invest in bonus certificates with a remaining maturity of more than three years.
• Don't raise the bonus level to the detriment of the barrier. If the barrier is breached, the bonus will disappear along with it.
• Don't use the bonus certificate for frequent in and out trading.
• In worst-of bonus certificates, don't use more than 2, eventually 3 underlying assets.

Classical variants

• Capped bonus certificates: the cap is usually placed at the level of the bonus; the structure then resembles a barrier reverse convertible with a non-guaranteed coupon.
• Worst-of bonus certificates: the product has several underlying assets, and any one breaching the barrier knocks-out the protection along with the bonus. The imperfect correlation of the two assets can be used to lower the barrier or raise the level of the bonus; it can also be used to increase the level of the participation.
• Clicket bonus certificate: once the underlying asset has reached a certain price level, the bonus certificate transforms itself in a capital guaranteed product, with an unconditional capital guarantee.