Why can investors hardly gain from Snowball?

Feb 1, 2023

Snowball product is a structured derivative consisting of additional options on basic financial assets.

Snowballs include the following 5 elements:

1. Underlying assets: stocks, stock indexes, or other financial assets.
2. Beginning price: the initial starting price.
3. Knock-in and knock-out boundaries:?The knock-in price is the lower limit value of the underlying asset for the initial price drop; ? The knock-out price is the upper limit value of the underlying asset for the initial price increase when the product breaks through the knock-out price, it brings the snowball to terminate and pay the proceeds.
4. Observation frequency ? Fixed dates set before product expiration to observe for knock-in/knock-out events.
5. Coupon rate: the annualized interest rate

The essence of Snowball product is to Sell Naked Put (with knock-in and knock-out) to the broker.

From the investors’ perspective, Snowball provides buffer space but limited profit margins. As long as the price of the linked underlying asset does not experience a sustained unilateral drop, the longer the holding period, the greater the profit potential.

1. If a knock-out event occurs during the holding period, the product will be terminated early, and investors will make a profit (coupon rate/ 365 * holding days).
2. If no knock-in or knock-out event occurs during the holding period, the investor will make a profit (coupon rate/ 365 * holding days).
3. If a knock-in event occurs during the holding period no knock-out event occurs, and the end-of-period price is higher than the beginning-of-period price, the investor gets the principal.
4. If a knock-in event occurs during the holding period but no knock-out event occurs, and the end-of-period price is lower than the beginning-of-period price, the investor will lose money (the loss is the actual decline in the target).

However, if we take the side of a broker, selling snowball products usually means a lot of profit, and rarely causes a loss.

1. Investors may not receive the premium. Broker as the buyer of the naked put needs to pay the investor a premium. When a knock-in event occurs but no knock-out event occurs during the holding period, and the end-of-period price is higher than the beginning-of-period price, the investor will recover the principal but cannot receive the premium.
2. It is easy for investors to become the scapegoat of brokers. Once the underlying asset falls sharply, brokers will inevitably exercise its rights, therefore investors will take over positions and losses for brokers.
3. Brokers can achieve the purpose of hedging risks through the snowballs. The main profit of brokers comes from high-frequency trading by buying low and selling high, and the existence of snowball products just provides a way for brokers to hedge. Delta is a measure of how much the option price changes when the underlying price changes by 1 unit. Brokers can achieve Delta Neutral by adjusting the ratio between the underlying assets and snowballs to achieve hedging purposes.

From the point of view of the characteristics of Snowball products, investors must have the ability to estimate the future trend of underlying assets when buying Snowballs, otherwise, it is simply spending money to cover for brokers.

When the market has risen sharply, it is easier to knock out, and meanwhile, investors are more likely to miss the rising market. When the market falls sharply, it is much easier to trigger the knock-in and bear the major losses for brokers.

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The information and the contents do not constitute investment advice on the performance of any specific financial instrument in a specific market, at a specific price, or at a specific time. The content of this article is not for anyone to constitute guiding investment advice, subscribers should make a reasonable assessment of this document and make investment decisions considering their financial situation, investment objectives, risk tolerance, and so on, and bear the investment risk independently. Subscribers' reference to and use of the information contained herein is subject to their assessment of its suitability and appropriateness. Arc Cap Co., Ltd. shall not be liable for any consequences based on or about the content of this article.