Analysis on the downfall of rate of return for issuers of Equity Linked Securities and possible solutions via hedging with newly structured products

Abstract

Equity Linked Securities products, also known as ELS, were and still are one of the most sold financial products in the Korean Market ever since the early 2000s. The issuers of ELS products, however, started to recognize lower rate of return than the heydays of ELS products due to the decrease of volatility levels of global markets. This paper focuses on how the downturn of global markets volatility level correlates with the rate of returns decrease for issuers of the ELS product and the solutions for hedging the already accrued risks of the ELS products that were issued with high volatility. Along with the fall of global markets volatility, the conventional hedging methods of ELS products Vega risk such as Listed / OTC (Over the Counter) options hedge, issuing ELS products with notional protection, etc. are no longer as effective as it used to be during the mid-2000s when ELS products were at its most liquidity

In order to successfully hedge the Vega risk of ELS products, this paper suggests including Short Vega type of financial products to the hedge book, which differs from the common Long Vega products such as Multi Asset Step-Down Auto-callable ELS Products: Reverse Accumulator and Worst of Call products. With these Short Vega types of products it will effectively diminish the already high accrued Vega risks. By creating a virtual portfolio with different types of ELS products, when these new products were included the portfolio was able to drop off around 40~50% of the original Vega amount as well as 30% of the Delta amount. In addition, this paper suggests how it is important to know the overall volatility levels for different markets respectively, and therefore suggests building up the volatility surface in order to successfully hedge the overall Greek Risks