The $300 Billion Structured Notes Market Is Booming

The structured products business in the US has gotten very large recently — on track to hit $300 billion in sales this year. That they are all the rage means a once opaque financial product is getting a lot more attention. So what are structured products, exactly, and how are they influencing the economy? In short, structured products are basically a fusion of a bank IOU with a derivative product, but that underplays how complex these things are and how they are shaping market dynamics. What is particularly interesting about structured notes is how they've become a stand-in for how investors are betting on the AI trade — the ways these products are structured allow market actors to really capitalize on some of the turbulence we're seeing. On this episode, we speak with Alex Micalizzi, who is the international head of equity structured notes at Nomura, and he gives us what might be the clearest explanation of how structured products are created, how they work, and why sales in structured products have grown so much in the last year. Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox, plus unlimited access to the site and app. bloomberg.com/subscriptions/oddlots https://www.bloomberg.com/subscriptions/oddlots?in_source=oddlotspodcast Join the Odd Lots Discord: discord.gg/oddlots See omnystudio.com/listener https://omnystudio.com/listener for privacy information.

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• 2:29Tracy Alloway?

  Hello and welcome to another episode of the All Thoughts Podcast. I'm Tracy Alloway.

• 2:33Joe Weisenthal?

  And I'm Joe Weisenthal.

• 2:35Tracy Alloway?

  Joe, I'm going to warn you in advance. This is one of those episodes that's going to come with a lot of Greek letters, I think.

• 2:41Joe Weisenthal?

  I like these episodes. You know, it's funny, some people, listeners, they'll tell us, they're like, you know, I love listening to All Thoughts. I have to admit, there are a few episodes I don't like totally get what you're talking about. And I'd be like, I don't really get what we're talking about either. But I, but I, but I, you know, I aspire.

• 2:58Tracy Alloway?

  But we like to aim high.

• 2:59Joe Weisenthal?

  Yeah, we like to aim high on this podcast. That's right.

• 3:02Tracy Alloway?

  All right. Well, I think this is actually an important episode. We're going to be, I don't think we've ever devoted an entire episode just to this topic. We probably touched on it at various points in time, but today we're going to be talking about structured notes. And I think this is important because we're used to talking about markets as these sort of fundamentally driven things. Like, what's the bull case for AI? What's the bear case for AI? But there are all these technical flows that also have an impact on markets. And I think we're in one of those moments right now.

• 3:33Joe Weisenthal?

  No, totally. So I think a couple of things. First of all, you know, we are in this moment where like, look, anything AI related has been up an extraordinary amount over the last few years. That's undisputable. And in fact, if you look at like expectations going over the next couple of years, all you see are various straight lines into the right. So revenues, capital expenditure, all of it, it all looks pretty good. But we are clearly in this moment of turbulence. If you just look at, say, certain aspects of the market, whether we're talking about some of the Neo clouds, whether we're looking at credit default swaps, even credit default swaps on some of the really big companies are starting to inch up. I mean, I hadn't seen anyone post a chart of Nvidia credit default swaps up until recently,

• 4:17Joe Weisenthal?

  but they're inching up just a little bit. There is clearly like, it's like the planes like rattling at high speeds here. And one of the ways that people have expressed bets on the AI trade is through structured notes, which as you've mentioned, we've mentioned in various episodes, but I don't think we've really devoted an episode to them.

• 4:35Tracy Alloway?

  Yeah. So this is one of the things when markets start to get kind of crazy, we tend to see more of these structured products sold. So, you know, people aren't satisfied with the 20% return in an AI name. They want to get 40% yields through a structured note on, I don't know, a core weave or something like that. And at the same time, there are also investors out there who start to get nervous at these valuations and they want to buy downside. And that's what some of these structured notes are doing. So today we do in fact have the perfect guest for all of this. We're going to be speaking with Alex Mikulitzky. He is a Managing Director and International Head of Equity Structured Notes over at Nomura. So Alex, thank you so much for coming on All Thoughts.

• 5:17Speaker 05

  And thank you so much for having me.

• 5:18Tracy Alloway?

  Why don't we go ahead and start with a super basic question? How do we define a structured note?

• 5:24Joe Weisenthal?

  Thank you.

• 5:24Tracy Alloway?

  Or a structured product? My personal preference is I like to describe it as like a bank deposit or a bank IOU. I don't know if they like met a derivative and had a baby. This is what it would be, but I'm sure you have a different definition.

• 5:37Speaker 05

  I was thinking the same thing, actually. So yeah, you give me a hundred dollars or you give the issuer a hundred dollars and you're foregoing an interest rate. And in return, you take the issuer's credit risk and they customize something related to the equity component. So there's, there's two things there. Either we customize participation, the interest that you missed will give you a call option or we'll give you a call spread or a fancy name for a call spread is a digital. Or we give you a bearish structure. You buy a put or a put spread or a put digital, something like that. Or the more common thing is yield. So you've got this foregone interest rate, this, and this extra credit.

• 6:18Speaker 05

  You can sell a put, that premium, we then get that premium and give you a coupon. And that coupon, if it's, it really depends on how much you want to amp up that yield. And so we can do things with that that make it, take it away from, hey, I could do this on the listed market by buying a put spread myself and I could have the rest of the money in a bank account. We do stuff that enhances that yield and generally that's in the, in the form of an auto callable. You can also mix and match. So there's a lot of bells and whistles here. You can combine yield with participation. And all these things, depending on who's selling it, have different types of names. But in effect, those are the three components. We take your money.

• 7:01Speaker 05

  We either give you a participation, we give you a yield and it's through a combination of options. And an extra layer of that is we add certain things to make the put that you're selling more desirable to us. So you get a higher type of coupon.

• 7:20Joe Weisenthal?

  Fantastic. I always think, and I've mentioned a couple of times on the show, that I love Manuel Derman, who we've had, uses this analogy of the Wall Street bank as a kitchen and they give, they sell fruit salad. They buy a bunch of fruit in wholesale, apple, they buy a bunch of fruit in wholesale, but then they can chop it up in any different way possible to create any instrument that me, the customer wants. And then they sell it to me and then they charge a little margin. And by, because they're capable of chopping up the fruit in some way, they could, any view that I want to express or any concern or any risk that I want to hedge with those raw ingredients who can give me anything. Now, who is the natural buyer?

• 8:04Joe Weisenthal?

  Because if I'm interested in AI, I'd go, I'd SPY, I could buy QQQ, I could buy a memory ETF. If I'm nervous, I could sell whatever. Who are some of the natural buyers of structured products from the bank?

• 8:18Speaker 05

  Predominantly high net worth individuals through the private bank channels. I would say that why they want this is people understand a yield, right? And people understand what that means relative to owning a linear stock and the type of protection I can get. And so they can't, in a lot of, in a lot of ways, they can't structure this themselves. Like, they can't go into the market. And we'll get into some of the more popular types of trades, which involve worst ofs and correlations and things like that and auto collables. You can't physically do that in the listed market space. And so this product offers that ability to enhance yield that you just can't get by selling, say, a particular stock downside.

• 9:03Speaker 05

  And with that comes, I think what you initially said, some of the complications and some of the things that end up driving some of these market factors as well, because. How we end up hedging this.

• 9:14Joe Weisenthal?

  Yeah.

• 9:14Speaker 05

  And the residual of what's left creates a very interesting dynamic that we're starting to see.

• 9:19Joe Weisenthal?

  Good.

• 9:20Tracy Alloway?

  So you mentioned this particular moment in markets. Talk to us about what we're seeing in terms of issuance or what we have been seeing in terms of issuance. I'm used to thinking about a lot of these things as single stock calls, right? So again, like something like, something that's tied to a core weave. And if the stock collapses by a certain amount before the note actually matures, then you either get all your money back with the interest or you lose out completely. But I know that we've seen a lot more index products as well.

• 9:50Speaker 05

  Yeah, so there's a multitude of things going on. We can start with index. So the stuff you're predominantly seeing on the index, which is creating interesting market dynamics in the longer dated option market is related to a US issued type product. So if we look at the structured product business in the US, it's got larger and larger. I think SEC registered notes this year are on track to hit about 300 billion versus approximately 200 billion last year.

• 10:22Joe Weisenthal?

  Okay.

• 10:23Speaker 05

  And a large change has been, the biggest contributor is S and P. But the greatest growth has been worst of order callables, which generally have S and P, NASDAQ and Russell. And why that's the case is you look at something like the Russell index. And for many years it was basically sideways. And from Liberation Day last year, it's effectively been in a straight line. So it's meant that these order callables that have been issued on this have knocked out, which is a whole topic we should talk about and of itself. So let's just step back a second. An order callable, why is it different? Why is it giving you a larger yield than just a plain structured product?

• 11:08Speaker 05

  So an order callable is a product that can knock out earlier than its effective maturity date. Generally, if the stock is above its initial performance and it's periodically looked at. So we generally will put on a trade and let's start with a simple S and P.

• 11:27Joe Weisenthal?

  Yeah.

• 11:27Speaker 05

  Three year trade or five year trade that we observe every three or six months. If after six months, this product, this S and P is higher than when you initially put it on, the product disappears and knocks out. And so that yield is the last time you're going to get the yield on this product. Then you have to reset. Why does that give you a higher yield than just selling a three year put on S and P? Well, a put is worth more as an index or stock goes down. So from my point of view, if S and P has rallied, this put in and of itself is worth less. So I don't have to worry about it anymore and it's got less value. So you're taking a contingent bet now and that increases the yield of the product.

• 12:11Speaker 05

  I don't need to put if S and P is up 30% if its value is a lot less than where it was beforehand. But it also creates a risk for an investor. As if markets are volatile and you enter this product, it means volatility is, or implied volatility is higher. The premium that I get to be able to invest in a coupon is higher. But if we rally and volatility falls, my reinvestment risk now is that the coupon yield I get the next time around is lower.

• 12:39Tracy Alloway?

  It's like convexity in mortgages, I guess.

• 12:41Speaker 05

  Yeah, it's basically, it's a relationship between the direction of the market and volatility. We generally think that as markets go up, volatility goes down. To some extent, as markets go down, volatility goes up. And so that dynamic is important in this product. So an order callable gives you a higher yield because of that feature.

• 13:02Joe Weisenthal?

  Why is it called an auto callable?

• 13:04Speaker 05

  Because.

• 13:04Joe Weisenthal?

  Let's talk about this word.

• 13:05Speaker 05

  Yeah, auto, on day one, once we put the initial, once we know where the initial spot price is.

• 13:12Joe Weisenthal?

  Yeah.

• 13:13Speaker 05

  We will periodically look at its value.

• 13:16Joe Weisenthal?

  Yeah.

• 13:16Speaker 05

  And it will auto knock out if the value.

• 13:19Joe Weisenthal?

  And what does knockout mean?

• 13:20Speaker 05

  Knockout means the product, I give you a hundred dollars back.

• 13:23Joe Weisenthal?

  Yeah.

• 13:24Speaker 05

  I give you a coupon, we're out. So we started with a three year product. We observed it every, every three months. Stock has gone up or the index has gone up. It's knocked out. Basically, the trade terminates.

• 13:35Joe Weisenthal?

  Oh, I see.

• 13:36Speaker 05

  As opposed to having a three year termination, it's now a three month termination.

• 13:39Joe Weisenthal?

  Let's go, actually, let's stick with this because we really need to understand this in detail. I entered this trade, let's, let's just say, let's keep it super vanilla. Let's just say it was one index.

• 13:50Speaker 05

  Yep.

• 13:51Joe Weisenthal?

  S and P 500 or NASDAQ or something like that. I entered it a year ago. I gave you a hundred dollars. What are you, what are you telling me I get back for that?

• 14:00Speaker 05

  So you.

• 14:00Joe Weisenthal?

  For a hundred dollars, what am I getting?

• 14:02Speaker 05

  You're going to get a coupon.

• 14:04Joe Weisenthal?

  Okay.

• 14:05Speaker 05

  When it will pay whatever periodically and you will get downside.

• 14:10Joe Weisenthal?

  Presumably higher than what I would get on a treasury?

• 14:13Speaker 05

  Yes.

• 14:13Joe Weisenthal?

  Okay.

• 14:14Speaker 05

  Well, it depends on other factors as well because you may want to have some.

• 14:18Joe Weisenthal?

  Some liquidity exposure.

• 14:19Speaker 05

  Yeah, exactly.

• 14:21Speaker 05

  But generally that, that's the sort of benchmark where people are not very interested if they're getting less than the risk.

• 14:26Joe Weisenthal?

  Yeah.

• 14:27Speaker 05

  But in order to give you a higher level than the risk free rate, you're also selling some sort of put option to me.

• 14:34Joe Weisenthal?

  I see.

• 14:35Speaker 05

  And there's variations on that put option. We've been in an upward market for a long time, so we haven't, but, sorry.

• 14:42Joe Weisenthal?

  No, no, so this is great. So I give you a hundred dollars. You are going to give me some coupon that is presumably, but higher than I could get just by paying a treasury. And in return, essentially what I am giving up is some participation in this upward move of the stock.

• 14:59Speaker 05

  Some participation and in a lot of cases, you are taking a downside risk, which isn't linear to the S and P performance. There's a generally a buffer, some protection. And there's variations of what that protection is. So if we say, we'll take a typical example of a knock in put and we'll put a 60% strike.

• 15:19Joe Weisenthal?

  All right, let's talk about what that means.

• 15:20Speaker 05

  So that means that if S and P, you start day one at a hundred dollars.

• 15:25Joe Weisenthal?

  Yeah.

• 15:25Speaker 05

  And it's a one year, it's a one year trade and we observe it every three months on the order callability. If S and P is down 20%.

• 15:33Joe Weisenthal?

  Yeah.

• 15:34Speaker 05

  You still have protection until you hit down 40%.

• 15:39Joe Weisenthal?

  Okay.

• 15:39Speaker 05

  At which this will, in this example of a knock in put, you will get the same equity participation as of being, as of owning S and P. So you get all the downside as if from a hundred dollars, but it has to be below 60.

• 15:53Joe Weisenthal?

  Okay.

• 15:54Speaker 05

  That's a general structure. Other structures are you just sell a vanilla put there. So your, your put payoff comes in at that 60%.

• 16:00Joe Weisenthal?

  Oh, I see.

• 16:01Speaker 05

  Point. But there's a lot of variations, bells and whistles on that. And that creates a digital exposure, which we'll talk about because that, that drives a lot of what we're seeing in the market. And the more risk you take, for example, take the example of the 60% knock in at a hundred. From 60% down to zero, I basically have a hundred percent risk. So basically, if I go down to zero, I've lost a hundred dollars. And so I can expect to get more premium for that as opposed to just selling a vanilla put where the most I can lose is 40%. And that changes the coupon as well.

• 16:52Speaker 00

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• 17:08Speaker 06

  We're seeing a lot of institutional players come in, digital asset dedicated hedge funds, high frequency traders and that sort of thing, and folks who service institutional clients.

• 17:17Speaker 00

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  A lot of regulators globally would like to keep the industry at arm's length. That's the opposite here. I think also what you'll find is that regulation and frameworks can come out, but some of them are maybe a slight iteration on some 80 year old policy and not actually in line with what the technology can do and offer. And again, that's very different in Dubai.

• 17:44Speaker 00

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• 20:24Tracy Alloway?

  You mentioned worst of autocallables before. When did those become a thing? Because the idea of like tying a product to the single worst performing stock seems kind of risky to me. And yet they seem to have become more popular.

• 20:38Speaker 05

  Yeah, I'd say they've historically they've always been there. Like I can't remember a time not having a worst of. It comes down to the yield factor. So what is a worst of? Instead, in the example we just had now, we had S and P and it's down 40%. We take a typical structure in the market that has S and P, Nasdaq and Russell and a worst of. We now observe the worst performer. So you could have two of these indices up 20% and you could have, you know, the Main Street, Wall Street sort of trade and one of these indices really underperform. You could end up with that put.

• 21:18Speaker 05

  And so it's going to derive more premium, more premium from just selling a one index, which gives you a higher yield. And it's also going to create additional risk factors for us because we have to model how these three things are moving together. And also it means that there are cases where what's the best, what's a great outcome for someone who has this yield? And say it was done during a time of turbulence and the yield is very high. The best sort of outcome is two of these stocks rally and one of the stocks is marginally down and just stays there. And the volatility on this thing does nothing and it goes sideways.

• 21:59Speaker 05

  You're now, I wouldn't say locked in, but you now have a relatively high yield than just doing S and P that's going up, right? That complexity of trying to monitor the worst one and, and being able to hedge it is I think a segue to what's trading in the market and why it's creating this market dynamic or why it's grown, sorry. And so you look at the, the three assets, the Russell, S and P and Nasdaq trade. You basically have had all three of these indices and Russell over the last year. Russell was effectively sideways for many years. It's now performed a lot better. And so think about this, what drives volumes in an autocall is a knockout.

• 22:43Speaker 05

  I can have a five year trade, but if these three indices or three stocks or whatever go up every three months, I can do a five year trade now has the same notion of every three months. So that volume goes up considerably.

• 23:00Tracy Alloway?

  Just before we get more into the market impact of all of these, talk to us about what's happening, I guess, on your side of the desk when you actually issue one of these products. So you mentioned, you know, having to model the correlation between three indices just then. What's the first thing you do when you sell one of these?

• 23:17Speaker 05

  Okay. So the first thing we do is we eliminate the delta. So we hedge the delta. That's the simplest thing. We're not taking a directional view.

• 23:24Joe Weisenthal?

  Is that some Greek letter?

• 23:26Speaker 05

  Yes, it is a Greek letter.

• 23:27Joe Weisenthal?

  What does it mean again?

• 23:28Tracy Alloway?

  I said there be Greek letters.

• 23:29Joe Weisenthal?

  I don't know. What's the delta again?

• 23:31Speaker 05

  The delta is the relationship between the price of this product and the spot price of a stock.

• 23:39Joe Weisenthal?

  Okay. Right. Excellent. Keep going.

• 23:42Speaker 05

  Right. So this product is bullish in nature. So as, as the, as the market goes down, we went through that 60, 100 thing.

• 23:49Joe Weisenthal?

  Yeah.

• 23:50Speaker 05

  I'm on the other side of it, so I have a short delta position. I'm short the market. The first thing we do is we hedge that out. Now we're left with more interesting Greeks. And so at a headline level, what have we got? And let's take the example of the one year single S and P example. And let's take the autocall. The maximum maturity of this thing is one year. And I own some sort of put on that one year trade with the risk of this thing not existing every three, six, nine, 12 months. So I've got Vega on this put and what's Vega?

• 24:29Joe Weisenthal?

  Thank you.

• 24:30Speaker 05

  Vega, Vega is the put sensitivity to the implied volatility.

• 24:36Joe Weisenthal?

  Okay.

• 24:37Speaker 05

  I've got Vega there and I've got these quarterly knockout features. So what are they? What, what is a knockout? A knockout is a fancy way of saying a, a digital and a, and a less fancy way of saying it's a call spread. I've got three call spreads there that I look at. And so that, that is a lot of options in that phase. And so what do we do? What, what, we have headline Greeks, so we look at our Vega. And a lot of my exotic brethren will probably go, well, that's not technically correct. But the way we generally look at it is when do we expect, or how long do we expect this thing to last?

• 25:19Speaker 05

  And it's probably gonna, we can model that sort of. And just say in this example, we say it's going to last six months.

• 25:30Speaker 05

  We will assign the Vega of this put at the six month level and we'll go to the listed market and we'll sell some sort of downside because it's related to that 60% strike and sell that out there. That's not really what's in this product.

• 25:46Tracy Alloway?

  Can I ask really quickly, who do you actually sell that Vega to?

• 25:50Speaker 05

  Yeah. So we generally use the broker or listed market. So we will go to the S and P market makers in this case. And we will, we'll go there, we'll either do it on screens or via the broker market. It's generally what we do in this case with the trend. Because like, we'll, we'll go to the trend a little bit later because I, I think it's important to understand why it's an imperfect hedge and what disruption that causes and how dealers, my colleagues have changed some of the trading methodologies as well.

• 26:27Joe Weisenthal?

  Let's talk a little bit about the action that we're seeing these days. And I guess to understand maybe the action these days, markets have gotten a little bit. Like I said, it feels like the plane is like rumbling a little bit or something at high speeds. But before maybe we understand right now, let's maybe start and go back to the start of the year. Let's start, okay, we're talking about, we're talking to you at the beginning of 2026 or maybe March 2026, three months ago or whatever. What are popular things that you're selling? And what are the popular thing to clients? And then what are the popular trades you're putting on to hedge those trades?

• 27:03Speaker 05

  Yeah. So I would say it's bifurcated. There's an index side. So US registered stuff, we talked about the $300 billion run rate. And then there's the single stock stuff, which is a very similar concept. But it's the, when we talk about maturities and we, we talk about these knockout dates, it's basically shrunk to a level that's creating a different dynamic. Let's start at the beginning of the year.

• 27:26Joe Weisenthal?

  Yeah.

• 27:27Speaker 05

  So markets are going up. This, this product is effectively on the single stock side, on the index side is knocking out. The single stock side is a lot faster because we observe it. Instead of every three months, some of this stuff we observe every day. And so this stuff is churning a lot. And in terms of hedges, there's less hedges because there's less Vega because the product isn't extending because markets are going up. So this is a pretty virtuous cycle because, you know, trades out, one comes in and your day one hedges are working and you don't have to think too much about it.

• 28:05Joe Weisenthal?

  All right.

• 28:06Speaker 05

  And then, um, you know, it's all honky dory as, as we say, until we hit some turbulence and certain stocks go down and indices go down. And that hedge, which isn't static and needs to be dynamic, changes. And the participant, the value of where I can hedge in terms of that implied volatility has also changed because a lot of people need to hedge at the same time. And the, some of the counterparties that were used outside of the listed market and IDB are pulling back because of turbulence.

• 28:42Joe Weisenthal?

  Okay.

• 28:42Speaker 05

  And so you have this concurrent effect of a lot of dealers have to now sell more optionality as markets are coming off. And a lot of the, I guess, the demand for it is also fading come August.

• 28:57Tracy Alloway?

  So just to be clear, you're left in a situation where the dealers or the issuers have a lot more Vega that they need to offload at the same time that I guess primarily the market makers are a lot more reluctant to take on that Vega.

• 29:12Speaker 05

  That is very well described. Yes. And again, that's because what was disappearing or knocking out every three months now seems to be having an extended maturity because the spot prices come down. And I think the market makers and are seeing all this supply come as these indices and stocks are coming off and going, well, what's happened? Like the last nine or the last seven to eight months, we didn't see this. Now we're seeing it. There's a yin and yang to this though.

• 29:46Joe Weisenthal?

  All right.

• 29:46Speaker 05

  And we, we've seen it on a lot of V-shaped recoveries. It's, hey, I've got this product. And I think in all fairness, if we look at the worst of three, it's generally three to five years. So that's where the, that's where, and with say, an expected life, we call it, when we expect that maturity to knock out of about two years. We see dealers hedging more and more of that as the markets come off. But all of a sudden, if these indices start to rally again, we could have a situation where this product knocks out in three months. And I am left just with my short hedges in the market and the.

• 30:29Speaker 05

  Supply is not yet there from my auto callable. So there's a situation where dealers can be left short. A lot of Vega on the street just on a small rally. And when, in all fairness, we're not too far from all time highs as it is.

• 30:44Joe Weisenthal?

  It's the funny thing. It's just the funny thing. We do these things like, oh, my God, the volatility, et cetera. And we're like, well, one and a half percent. I don't know from an all time high. It's kind of, yeah. Top market is doing fine.

• 30:58Tracy Alloway?

  Well, is this part of the, your colleague at Nomura, who's been on the show a number of times, Charlie McEliggett? He calls this the spot up vol up regime, right? Is this like part of why we're getting that situation?

• 31:10Speaker 05

  Yes, on, I would say it's even more prevalent on the single stock side. But on, on the index side, we are definitely seeing that just because of the growth of the, the worst of and the growth of the US SEC registered notes. We're seeing that dynamic in the longer dated. And there's just been, I guess, less capital committed to that, that Vega or less understanding of what's driving it. And it's basically this that's driving it, this, this factor that we just have more of this stuff in, in this bucket. On the shorter dated stuff, when we look at single stock, it's been driven by the same product, but the product complexity, it goes to another level.

• 31:53Speaker 05

  So when we talked about how do we get a higher yield?

• 31:57Joe Weisenthal?

  Yeah.

• 31:57Speaker 05

  And we said, hey, let's put these auto calls in there. There are other things we can do to get a higher yield as well. So we can put contingent coupons. So that's, that's basically means that I won't pay you this coupon if the, the stock or the worst of has fallen too much. So that's another thing we can do. We can also, instead of having the observation every three months, we can have it daily. And so that means any rally, this thing's gone.

• 32:28Tracy Alloway?

  Hmm.

• 32:28Speaker 05

  And if you look at something like that, it becomes very, very binary. We live generally in this type of structure. It's, it's on single stock name, worst of three. We let the stocks breathe, for want of a better term, for a month. And then we start observations on a daily basis. And these things typically go from six months to 18 months, maybe two years. So on every, every day, I might be left with no option, no Vega, no put. Or if one of these stocks goes down, I'm left with a lot of put value in that one year timeframe. So either I have vol here or I don't, and I'm now observing it every single day.

• 33:11Speaker 05

  So it's creating this on off type of market in, in the single stock names.

• 33:16Joe Weisenthal?

  Just to be clear, if I'm one of these high net worth investors and I buy one of these nodes, what do I typically want to happen? I wanted to last the entire lifetime and just keep clipping the max coupon possible. Like, what is the sort of ideal market regime for me as the buyer?

• 33:35Speaker 05

  As the buyer, the market regime, things are very volatile. So my, my yield from this put selling is very high and things quieten down and markets have drifted lower.

• 33:47Joe Weisenthal?

  Okay.

• 33:48Speaker 05

  Not in a volatile way, but they've just drifted lower and the world has become nice again. And I'm left with this really high coupon for as long as possible. That is, that is the outcome. And so.

• 33:59Joe Weisenthal?

  So if it goes up too fast, then the note is over and I don't get all my coupons. If the market plunges, then I'm actually potentially in the red because I'm outside of this buffer zone and I'm actually exposed. But if we get this nice little quiet thing, maybe a little bit lower, et cetera, then I get that coupon, it lasts for a very long time and I'm not picking up any downside.

• 34:19Speaker 05

  Exactly. That's what you want. And, and so when we get those drift downs, it's when we generally get this vol dynamic.

• 34:26Joe Weisenthal?

  Yeah.

• 34:26Speaker 05

  And it's happening in the skew. So when I said knockouts and coupon contingent, again, digitals, fancy words for put spreads and call spreads.

• 34:34Joe Weisenthal?

  Why is it called digitals?

• 34:36Speaker 05

  Because it's, it's binary. It's either.

• 34:38Joe Weisenthal?

  It's binary, right?

• 34:38Speaker 05

  And so it's either zero or one. And so if we think of these things as put spreads and call spreads, we're now going into another dynamic, which is skew. So we can look at volatility and say, hey, at the money volatility is 30. But what really matters in these type of products is how steep or not steep the skew is. Because we really have the, this clump of put spreads and call spreads on, rather than just this outright Vega. And I guess the question you would ask, I think, is, hey, you told me you just sell one put.

• 35:12Joe Weisenthal?

  Yeah.

• 35:12Speaker 05

  Why are you doing that when you've got like these?

• 35:15Tracy Alloway?

  I was just about to say exactly that. Exactly that question.

• 35:18Joe Weisenthal?

  Keep going.

• 35:19Speaker 05

  Because to replicate, to replicate those put spreads in the, the notion or the dollar sum we're trading, it's just not conceivable. It's just, there's too many of these things we have to do. There's, in a lot of cases, especially the single stock, which is changing. There's not daily option markets. And the bid offer spread would just be too high to try to even contemplate doing this.

• 35:42Joe Weisenthal?

  Yeah.

• 35:42Tracy Alloway?

  Actually, this reminds me of something I wanted to ask you, which is, correlation is one of the like trickiest things in all of finance to model. And I'm very curious how often the models disagree, I guess, internally on a potential outcome. And if there is disagreement or if there is uncertainty, where does that actually get priced? Does it get priced like in, in the coupon that you're paying out to the investor? Or do you, I don't know, add like an additional reserve or something like that?

• 36:11Speaker 05

  Combination of all those things. So I guess the, the modeling component, like the, we, we think of finance as this risk neutral world. And so if you look at, if you look at that empirically and the returns on equities, it's not risk neutral to start with. We also have liked to look at markets in terms, so basically markets have gone higher than what a risk neutral rate would suggest, right? And so a lot of these products, they're based on the expected knockout date because a big component of this is the funding. You gave me, you gave the issuer a hundred dollars. How long is that going to invest for, right? And so we base it on risk neutral.

• 36:54Speaker 05

  So that in and of itself is a constraint. But also what can we observe? The selling the put, we can observe implied volatility in the listed market. And so we can build a volatility surface on that, a local vol surface. But if you look at this actual trade and we look at the, let's go back to that simple three month quarter, quarterly knockout. And the knockout again is that put spread. I've got a series of these put spreads that are forward starting. All right. So I've got a, you know, in three months' time, am I going to have to do something in that, our next three month bucket? So you've got forward starting risk. And when we look at local vol and the construction of local vol,

• 37:36Speaker 05

  it really, really underestimates the relationship between these dates going forward. So to cut a long story short, there's modeling assumptions that we use and we, we look at stochastic volatility to try to take into that into account. And that's just, again, some of this stuff is opaque because one of the components of stochastic volatility is vol of vol. And you can't really observe vol of vol outside of maybe VIX options. And so on a single stock name, you can't do that, especially when you get to these daily knockouts.

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• 41:57Joe Weisenthal?

  With the single stock structured notes, which ones, what are the popular ones that we're talking about here?

• 42:04Speaker 05

  Yes.

• 42:05Joe Weisenthal?

  Nvidia, Apple, Meta, what are like, what are people buying?

• 42:08Speaker 05

  Semis.

• 42:10Joe Weisenthal?

  Okay.

• 42:10Speaker 05

  You've got the hyperscalers.

• 42:13Joe Weisenthal?

  Other ones for the Neo Clouds? Are there people buying?

• 42:16Tracy Alloway?

  There's a core we've won in Asia. There's probably some in the U.S. too, but our colleague at Bloomberg, Shulie Ren, wrote a really good column about it, 40% annualized yield.

• 42:25Joe Weisenthal?

  That's pretty sick. So actually, I was gonna thank for bringing that up. Just to be clear, when you're talking about, you said $300 billion market this year?

• 42:34Speaker 05

  And that's predominantly on, that's just U.S. registered.

• 42:39Joe Weisenthal?

  So this is U.S. money?

• 42:40Speaker 05

  Yes, this is U.S. registered money.

• 42:42Joe Weisenthal?

  Okay, because my understanding is for as much as like, people talk about it here, this is like really big in Asia, right?

• 42:50Speaker 05

  Yeah.

• 42:51Joe Weisenthal?

  What is it?

• 42:51Tracy Alloway?

  One of my favorite headlines that I ever wrote was, I think it was when there was drama in the Chinese U.N. and a bunch of structured products in Asia got knocked out and I called it the Tarf Barf.

• 43:02Joe Weisenthal?

  Oh, that's good.

• 43:03Tracy Alloway?

  Thank you. Thank you.

• 43:04Joe Weisenthal?

  But can you explain what it is about high net worth in the U.S. versus high net worth in Asia such that there is a maybe more naturally economic reason why these products are so popular in Asia?

• 43:18Speaker 05

  I would say just because it's been around longer in Asia and it's.

• 43:24Joe Weisenthal?

  Is there a reason for that?

• 43:25Speaker 05

  I would say it probably started with Japan when interest rates went to zero.

• 43:32Joe Weisenthal?

  Oh.

• 43:32Speaker 05

  And the, the concept of Uridashi started where, hey, how can I enhance this? And then you get a coupon, hey, how can I make that coupon higher? And you add certain factors to it. And in, in markets, I guess this market, the U.S. market is more used to participation because just of.

• 43:52Joe Weisenthal?

  Yeah, I get it, I get it.

• 43:54Speaker 05

  And other markets have had different sideways down, whatever. And so having something that protects you a little bit on the downside and gives you a yield when maybe the equity performance hasn't been there starts to look more attractive.

• 44:09Joe Weisenthal?

  Now, these days, we're talking about, you're gonna get some pretty fat, pretty juicy yields in the United States these days. We're in this sort of weird situation in which, and it's kind of a rare situation historically in which stocks have done quite, quite well. And also rates have been going up and also spreads have been going up, particularly on many of the stocks that have been going well. It's a very strange environment. Does that lessen at all some of the appetite for structured notes when I don't have to get particularly exotic if I just want a coupon?

• 44:42Speaker 05

  Yeah, so in the U.S., if we actually look at the size of the market historically versus what the coupon or that yield has been, it's not as big as the total return. So what's, what that's telling me is that people, the U.S., in the registered space at least, are taking some of that return and using it as, as investment income as a dividend per se.

• 45:08Joe Weisenthal?

  Yeah.

• 45:09Speaker 05

  And so the market structure in the U.S. is different because this is a participation trade and this is something that diversifies and gives some protection to the downside.

• 45:21Joe Weisenthal?

  All right.

• 45:21Speaker 05

  And I think it's being used like that in, in the U.S. whereas in other markets, it's more about how can I get the highest return and the duration, like the maturities are less. And also the, the idea of reinvestment is higher as well in terms of taking this and doing it again.

• 45:40Tracy Alloway?

  You know, you mentioned less capital available in the, I guess, financial ecosystem for absorbing some of this flow. I don't want you to name specific counterparties or anything like that, but what is going on here exactly? Is this like a restrictive balance sheet thing or are people nervous about actually like expressing particular views? What's going on?

• 46:02Speaker 05

  I don't think it was views. I, I suspect that to protect portfolios, call options were being bought in the market. And as those portfolios changed and maybe shrank, the need for that went away.

• 46:15Tracy Alloway?

  Yeah.

• 46:16Speaker 05

  And so a large buyer who was that, large buyers that elevated option premium disappeared at the same time, well, I guess it's all related, as markets were coming off as well. And that definitely changed some of the dynamics in the market.

• 46:30Tracy Alloway?

  So what does that actually mean for issuance of structured products? If you can't offload the Vega to someone else, if you can't properly hedge, are you naturally limited in what you can do?

• 46:41Speaker 05

  Yes and no. I think there's, there is still a market. There is way more liquidity in the U.S. capital markets than anywhere else. And looking at this from the lens of trading in, in Hong Kong and Australia, there are real two, three, five-year equity markets that are hedgeable. I would say ultimately what drives issuance is the direction of the market. I would say if we do go sideways and there's less auto callable or we go down, you're just not going to get the demand for more, or historically, demand tails off. And that does also create a very interesting dynamic in the market.

• 47:22Speaker 05

  So the example of, I think we moved it from a one-year trade to a five-year trade. So the dynamic that we're seeing in the market is we've got typically through, with the U.S. registered, we've got three to five-year maturities with expected life of two years, you're selling two years. If the market goes down or the worst of goes down, the chance that this goes to five years becomes a real thing, right? And so all the vagas there. So that dynamic will, will mean there's no new issuance, but I'm now short this two-year trade and I really don't, I never had Vega there. I use that position as a proxy for the five-year.

• 48:03Speaker 05

  And so that term structure also changes where you can get the stuff that's depressed in the market having a higher value because you've just got your short hedge on and now you've got exposure to the five-year. And again, conversely, we get markets go back to all-time highs. I'm just left short the, the two-year and that's another reason it can go up. And when we look at this stuff and we model it, we, we call it, you know, peak Vega.

• 48:30Joe Weisenthal?

  So what happens if like, all right, people, you know, again, we're in this bow of like, oh, is the AI boom, is it coming to an end or something like that? Well, what happens if like, we really get some real, I mean, these moves aren't that big yet. Semiconductor ETF, I guess it's down, I don't know, maybe 10% from its peak or something like that.

• 48:49Speaker 05

  Yeah.

• 48:50Joe Weisenthal?

  It's not that big. What happens like if we're like, wow, you know what, we're really gonna reprice the AI trade in a meaningful way for some theory, the ROI is there, whatever. What, what happens to these products if we're like, all right, we got some moves here?

• 49:04Speaker 05

  So if we get really large moves in terms of, again, the, the client has, in effect, there is a directional component to this trade, right? They are short of put.

• 49:13Joe Weisenthal?

  Yeah.

• 49:14Speaker 05

  So in extreme situations, in these cases, there's $100 potentially at risk. And there's a point where depending on the type of put or how it was structured, that the dealer can be on, instead of being long gamma because of this put, it's really a put spread, I'm on the other side of the spread because it's gone too far. Now, that's another Greek word just introduced. I'm now short gamma.

• 49:40Joe Weisenthal?

  Yeah.

• 49:41Speaker 05

  Which means that I'm more susceptible to market moves and I exacerbate the market moves. I have to buy when market goes up and sell when market goes down. That's gamma, big short.

• 49:51Joe Weisenthal?

  Do you see like, all right, let's say a bunch of people bought these notes that don't take any hit until they're 40% down or something like that? Are there things that you see in the market when like, a bunch of these things are 38% down and they're getting close to that barrier or whatever? Are there fingerprints on the market that's like, wow, it looks like a bunch of structured notes are getting close to some of these levels? What would I expect to start to see happening?

• 50:19Speaker 05

  In, in all fairness, we haven't really seen a down market where those puts have been there. We see it on the knockouts more and we could describe, because that's probably, it happens once every three months rather than once every one, five years, but the concept is the same. So it's a digital, it's a call spread.

• 50:36Joe Weisenthal?

  Yeah.

• 50:36Speaker 05

  And either this product is going to survive and go on for at least another three months or it's not. So the fact that it's a put spread or a call spread, it depends what side I'm on, whether or not I'm long or short gamma. So the same thing on the put, if it's a knock input especially, depending on which side I'm on or approaching it, you get a gamma profile that can be short, that you being the dealer.

• 51:03Joe Weisenthal?

  So.

• 51:03Speaker 05

  Yeah. And so what that means is you can get exacerbated moves around those levels as a result of being close to those levels and having this binary outcome near those levels. So we, we see it often on, on the knockouts just because there, there's more of them and we face them more. But yes, in a period of, these things are down wherever the strike is, I think we said 40%. As we approach it, you'll start to get dealer short gamma and then when we're on the other side of it, you'll get the same sort of aspect.

• 51:34Tracy Alloway?

  Which is more painful, the, the slow like decline or the big overnight fall?

• 51:40Speaker 05

  That's, that depends. I would say the virtuous cycle is that the product markets go up and we get new trades and everybody's happy because there's a coupon.

• 51:52Joe Weisenthal?

  Yeah.

• 51:53Speaker 05

  Both of your scenarios, uh, there, there's many ways to die and that's slow grind down. And again, it depends on your hedging and what you've done can be painful because we've got this dynamic of hedging with two, left with five, wrong hedge, volatility is going lower, the skew is flattening. That can be painful. And what can also be painful is, hey, I've hedged and I described a put spread or call spread and I've just done an outright position. So locally I'm hedged, but on a large move, I'm not because my call spread or put spread only gives me X amount of value, whereas the thing I've sold has value beyond that. So there's

• 52:38Speaker 05

  a scenario where that's horrible too. And it really depends on, again, how these things have been hedged.

• 52:46Tracy Alloway?

  I have one more question. Some of these products are very creative in both their design and their hedging. Do you have a favorite, a favorite that you like to point to and go, hey, this was extra creative?

• 52:58Speaker 05

  Yeah, I'd say the, a po- popular, a product now, so we talked about the worst of, we talked about daily observations and we talked about what an auto callable is that we observe it and the worst performer has to be above that level to knock out. So one of the more creative auto calls we've seen is one with a knockout auto call feature. So say you've got three stocks and you've got observation dates that are daily. You can have one of these stocks that rallies 20% on day one, say the other two are down 10%. It's now considered knocked out regardless of what happens next. So then you've got two

• 53:38Speaker 05

  names left and the first stock is down 30%, kind of irrelevant. But the other two, or just let's, okay, another one goes up, it's gone. You're now got a position where the original stock, which was up 20%, is now down 40% and the original, the stock A, if it just rallies a little bit, the whole product disappears. And this thing is way down, like the stock that was up 20 is now down, you know, 50%. It's going to be like, it's going to have real put value, but that put value is all destroyed if this last guy gets knocked out. So I now have this, this way in the money put, which can disappear very, very

• 54:22Speaker 05

  quickly. And so I've got this massive vol of vol position where if everything just rallies now, it's done. I need everything to fall and it, it creates a really interesting dynamic. And I think it's what we're seeing in the very front in single stocks.

• 54:38Joe Weisenthal?

  As the clients get richer and richer, the last question for me, as clients get richer and richer, does the creativity with which they can purchase an instrument multiply as in, all right, you know what, here's this guy's worth a hundred million dollars. Here's a few items you can pick from the shelf. Here's a billion dollars. You know what, we're going to bring out the best chef for him and we're going to chop the mushrooms and everything and we're going to come up with something really creative for him. Is it the kind, it, it just in the nature of the business, the like, there's the other sort of more and more exotic versions that you can get depending on how much money you bring to the table?

• 55:15Speaker 05

  You, you can get more and more exotic. I would say that liquidity is a factor and generally what provokes or what creates these sort of structures is what created pain. So we had examples in 2018 of dealers getting into trouble and what created pain was that drift down. So a whole new product was created, not knock in, knock out, where if we drift down, but we haven't drifted too far and we stay in a certain area, we knock out as well. So I, I would say it's, and that, the level of vol of all that creates and, oh, this is a simple way to solve it, creates secondary issues.

• 55:49Joe Weisenthal?

  Yeah.

• 55:50Speaker 05

  But to, to your point, I, I would say as it gets more sophisticated or you get large institutional clients, the amount of structuring that can happen, it's possible, but it's more about size and handling liquidity.

• 56:03Tracy Alloway?

  All right, Alex, truly the perfect guest to talk about structured products. Really appreciate you coming on Odd Lots.

• 56:08Speaker 05

  Thank you for having me, guys.

• 56:22Tracy Alloway?

  Joe, I thought that was fascinating. There are indeed a lot of Greek letters involved, but I gotta say, I feel kind of bad for, for the market makers who are basically like the buyers of last resort for a lot of that Vega. And like, as the market does what it's been doing recently, they basically just have more and more that they have to absorb and then they have to hedge more and more and more. It seems hard.

• 56:44Joe Weisenthal?

  I guess I don't feel sorry for them. I mean,

• 56:46Tracy Alloway?

  I guess they're paid to do it, but still.

• 56:48Joe Weisenthal?

  It's hard, but that's what the money is for, you know? It's like, that's why they get paid well, because it's actually, it's very complicated to figure out where all these different like balancing prices are and how exactly, what exactly is the value of some of these things. But I don't feel bad for them at all because it seems like a job where not many people would have that skill. And if you do have that skill, you're probably getting paid very well. I really enjoyed that conversation overall. Help me sort of understand what these products are there, what problems they solve for the clients, why the client is getting compensated for them, why the banks like to sell them. It clarified a number of things.

• 57:25Tracy Alloway?

  Yeah. And I do also think it definitely underscored that like, sometimes the most painful environment isn't the big sharp move down or the sharp move up. It's that slow grind, which, you know, kind of is what we've been seeing recently.

• 57:39Joe Weisenthal?

  It's interesting, like US stocks, it just doesn't sell well for so long. I mean, that is like the big story. And I think about this all the time in many flavors of this conversation, where we talk about hedge funds and options and trading and stuff like that. It's like, man, you got paid in retrospect, sitting here in 2026, for basically the last 45 years, you got paid a lot of money to just invest in the market and do nothing, right? To buy the index or whatever. And with very rare exceptions, that's all you had to do to make a ton of money is buy the index and go swimming. But it's interesting to think about how, for example, in other countries, problems are a little trickier. It's like, how does someone in Japan get yield during all those zirp years and stuff?

• 58:20Joe Weisenthal?

  So you have to get a little bit exotic and stuff like that. Now I can understand why, you know, people sitting on some huge gains, they don't want to miss out on future gains, but maybe they want to like take off some risk. Now there's yield again in the United States over the last few years. That could be interesting and stuff like that. So I understand a little bit more about like inherently why these products have gotten more lucrative or desirable for high net worth American investors in recent years.

• 58:47Tracy Alloway?

  Sure. But I guess the issue is when the market becomes so big that it actually ends up impacting everything and you get these sort of weird like negative gamma instances where people have to sell into a down market and things like that. And it just sort of starts wagging the tail.

• 59:03Joe Weisenthal?

  Totally. And look, the market has gotten a little more turbulent. Like, again, I like to point out, it's not like we've had some huge crash or something.

• 59:10Tracy Alloway?

  No, we haven't.

• 59:10Joe Weisenthal?

  But it is, it has not been straight up. People are starting to look for the weak players and the links and so forth. People getting a little bit of anxious. And so it's sort of important to get a better grasp on like, what are some of the ramifications? If we were to see longer sideways market or God forbid, something resembling a bear market.

• 59:31Tracy Alloway?

  Learn your Greeks.

• 59:32Joe Weisenthal?

  Learn your Greeks.

• 59:33Tracy Alloway?

  Shall we leave it there?

• 59:33Joe Weisenthal?

  Let's leave it there.

• 59:34Tracy Alloway?

  All right. This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 59:40Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at thestalwart. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashil Bennett at Dashbot, Kail Brooks at Kail Brooks, and Kevin Lozano at Kevin Lloyd Lozano. And you can chat about all of these topics 24/7 in our Discord, discord.gg/oddlots. And for more Odd Lots content, check out our daily newsletter, which you can find at Bloomberg.com/oddlots.

• 1:00:04Tracy Alloway?

  And if you enjoyed this conversation, if you like it when we talk about Greek letters, then please leave us a positive review on your favorite podcast platform. If you're watching on video, then please leave a comment or a like, or better yet, subscribe.

• 1:00:17Joe Weisenthal?

  And remember, if you're a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there.

• 1:00:27Tracy Alloway?

  Thanks for joining.

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