[originally published Jan. 24, 2013]
As the price of Apple (NASDAQ:AAPL) has declined from over $700 per share to below $500 per share, it's not just Apple shareholders who are feeling blue. Wall Street sold a ton of "structured notes" based on the price of Apple stock as a "reference" security. And the frenzy for the notes was greatest in the weeks before Apple's stock price peaked in September.
Under these notes, often called "reverse convertibles", it appears to an investor that he or she is buying a fixed income or bond-like investment which would rise as the price of Apple rises and that the return would mimic or exceed the return of the Apple stock while acting like a bond. Unfortunately, as Apple has cratered in value, so has the value of the Apple-based structured notes.
Many brokers pushed the structured notes as "safe and guaranteed" ways to benefit from the Apple rise without the risk. Unfortunately, the opposite is true, as Apple has plummeted.
This means that investors who thought they were buying a fixed income product get beaten up Apple shares which they never intended to buy.
One or two reporters have picked up on the dangers such structured notes linked to Apple pose for investors. Back in December, the risk in such Apple-linked notes became apparent, according to Kevin Dugan of Bloomberg.
"More than $241 million of structured notes tied to Apple Inc. face losses after a 27 percent drop in the stock of the world's most valuable company eroded built-in cushions that protect investors," Dugan wrote. "Banks issued 76 US notes linked to Apple stock during the seven weeks starting August 20 when the company was valued at $650 a share or more," Dugan continued. In total, banks issued $1.66 billion of such notes, making Apple the most popular underlying company in such high commission structured products.
Some stock jockeys very likely sold the product without explaining to investors the incredible risks they faced. Indeed, many of the securities were created to absorb a 20 percent decline in value before investors are at risk of losing principal or coupon payments, but the stock has dropped more than that already.
And Apple-linked structured products aren't the only culprits in the market. The same holds true for other structured notes which have seen a decline in the past year such as notes based on oil prices or other declining indexes.
Meanwhile, Apple released its earnings Wednesday afternoon, and, despite the company's record revenue and profits, investors were not impressed. There is fear in the market that Apple has peaked. Its share price was down more than 7 percent in after hours trading to $482.45. That's down 30% off its September high and means there is real trouble ahead for clients who thought they were paying a bond linked to Apple but instead are winding up with a tech stock that is cratering.
Investors simply need to avoid these complex, high risk products.
Disclosure: Zamansky & Associates are securities attorneys representing investors in federal and state litigation and arbitration against financial institutions.