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Financial Products tied to FAANG are in the Barrel

FAANG, which stands for Facebook, Amazon, Apple, and Alphabet (Google’s parent company), have led the charge during this market cycle’s historic bull run.  But in recent weeks,  and yesterday’s earnings miss from Amazon, FAANG stocks, and financial products tied to FAANG stocks have shown that they are not impervious to market corrections.

Structured products tied to the FAANG are of particular concern.  These products can be marketed as a fixed income alternative with an attractive interest rate.  They can purport to offer exposure to FAANG stocks supposedly without the volatility associated with holding the equities themselves.  These notes, however (often unbeknownst to the folks who buy them), can have unlimited downside risk if a “knock-in event” occurs.  A knock in event is generally triggered when the underlying equity attached to the structured note falls a certain percentage.  For example, suppose Joe Investor buys a structured note tied to FAANG stocks that market a 10% interest rate.  Suppose the knock in event occurs when some or all of underlying FAANG stocks fall 30%.  If the knock-in event occurs, Joe can lose some or all of his investment.

Many folks who purchased or sold these FAANG structured notes did so with the feeling that a knock-in event (i.e. a steep decline in FAANG stock price) would never occur.  Doesn’t seem so unlikely now.