Important factors when choosing reverse convertibles
Under no circumstances should the first available reverse convertible be used, but the investor should first deal with the nature of the derivative and the most important factors influencing its development and earnings in detail before making a purchase. Because when choosing the right reverse convertible, several factors play a role.
The product
When choosing a reverse convertible, investors usually look first at the maximum achievable return. However, this behavior should be viewed with caution, as higher interest rates usually indicate higher risk. Because the greater the volatility of an underlying asset, the more likely it is that a reverse convertible on this underlying asset is not the best investment. So that investors can still access it, they are lured with particularly high interest rates.
Investors should therefore always pay attention to the base price. A reverse convertible is all the safer the lower the base price is below the current price of the underlying. Because then there is a higher probability that the bond will be redeemed at par and that the investor will not receive shares that are worth less. In return, however, as with most safe investments, the return is lower. In addition, the investor would have made a higher profit with a direct investment in the shares if the shares were also listed significantly above the base price on the valuation date.
If the reverse convertible is not bought when it is issued but at a later point in time via the stock exchange, you should also pay attention to the purchase price. Ideally, this is 100 percent or just under. If the price at which the reverse convertible can be bought is well below 100 percent, there is a high probability that the repayment will be made in shares. A price of more than 100 percent, on the other hand, has a negative effect on the possible yield, since the reverse convertible is repaid at most 100 percent on maturity.
The remaining term also affects the price of the reverse convertible. The shorter the remaining term, the more likely one of the two payout scenarios becomes. If the base value is quoted above the base price, the value of the reverse convertible increases as the remaining term decreases, as it becomes less likely that the share will fall below the base price and a repayment in shares will take place. Conversely, the value of the reverse convertible falls when the base value moves below the base price with a short remaining term, as the probability of a recovery decreases.
The base value
The investor should be familiar with the share, or in general with the underlying asset on which the bond is based, and should have observed its development. In addition, he should be in a position to be able to roughly estimate the further course development. Reverse convertibles, which are based on equities or indices with high volatility or strong downside risks, should be avoided. Only reverse convertibles should be considered that have an underlying value that is believed to be stable.
With regard to the possible delivery of the underlying at the end of the term of the reverse convertible, care should also be taken to ensure that the underlying fits into your own investment concept or portfolio. When selecting the reverse convertible, it should also be considered in connection with the underlying that the underlying is usually only delivered in the case of German shares. If foreign stocks, indices or commodities are used as the underlying, the underlying is not delivered and a corresponding cash amount is paid out instead.
The market
An investment in reverse convertibles is particularly worthwhile when the market is in a sideways movement. Because if prices rise, the profit from the reverse convertible is capped, but if prices fall, the investor shares in the losses. However, since reverse convertibles usually have a term of several months up to one or two years, it is hardly possible to estimate the market movement in advance over such a long period of time. However, if a reverse convertible is only bought on the stock exchange a few months before the end of the term, or if it generally has a short term, you should pay attention to the market trend
The issuer
When selecting a suitable reverse convertible, the issuer must not be neglected. Since reverse convertibles are bearer bonds, the creditworthiness of the issuer plays a major role. Because the issuer of a reverse convertible has to file for bankruptcy, investors lose both their invested capital and the promised interest payments that have not yet been made. In order to minimize this issuer risk, an issuer that is as solid and renowned as possible should be chosen.
If the investor chooses a solid and well-known issuer, he can also benefit from their experience in trading reverse convertibles and their service. Large issuers such as Vontobel usually offer up-to-date and reliable prices and data on their products at all times, which can be accessed via the Internet.