As we step into 2024, the A-share market in China continues to experience volatility, arousing considerable concern among investors regarding the risks associated with snowball structured productsThese financial instruments have become a focal point in discussions among brokerage firms and their clients, especially with recent notifications indicating the precarious situations involving these investments.

To understand the current context, let’s examine a specific instance that sparked widespread conversation within financial circlesAn announcement from a brokerage highlighted a snowball product linked to the China Securities 500 Index, which had a maturity of 24 months since its inception on January 13, 2022. The product was set to expire on January 15, 2024. Investors had initially invested 2 million yuan, with a starting price of 7097.76. However, with a closing price of 5193.3, the index experienced a significant drop—over 25%—leading to a total loss of both the principal and the coupon for the investors involved.

But what exactly are snowball products, and why have they led to such detrimental outcomes?

Snowball products are essentially investment vehicles designed to provide returns over a specific period—typically 12 or 24 months—based on the performance of a referenced asset, which can be a single stock or an index

The term “snowball” is derived from the notion that, as long as there isn’t a catastrophic market downturn, the longer an investor holds the product, the greater the potential returnsThis idea is intrinsically linked to the gains that roll over like a growing snowballHowever, should the underlying asset decline significantly, the repercussions for investors can be severe.

These products are issued by brokerages, and investors purchase them to earn returnsTypically, a reference annualized yield is specified—say, 15%—which is only attainable under certain conditionsThe ultimate yield that investors can secure is shrouded in uncertainty, leading to a gambling-like scenario regarding market performance.

The underlying asset can range from individual stocks to indices; however, the majority of current snowball products in circulation are primarily pegged to the China Securities 500 and 1000 indices

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The return for investors hinges on the performance of these referenced assetsEssentially, when investing in snowball products, clients are betting on the stability of the underlying securities, hoping they do not significantly decline in value.

Consider the mechanics of this strategyAn investor buys a snowball product based on the belief that the risk of a fall in the price of the underlying asset is minimal, making it akin to an investor selling a put option to the brokerageIn finance, a put option provides the purchaser the ease of selling the asset at a predetermined price; conversely, it obligates the seller to buy the asset at that same price, regardless of market performance.

This contrast becomes evident when analyzing the implications of purchasing a put option—if the option holder has a set selling price of 100, even if the stock plummets to 2, they can still sell at 100, leaving the seller with a significant financial obligation when the time for option execution arrives.

The snowball product embodies the concept of selling a put option, wherein the risk magnifies considerably for the seller, especially during bearish trends

If the referenced index, such as the China Securities 500, declines substantially, investors quickly face mounting losses from their initial investment, especially when the safety measures surrounding these products are breached.

Despite the risks, the appeal of snowball products is quite pronounced, predominantly due to their perceived high win ratesInvestors are drawn to scenarios where the underlying assets exhibit minimal volatility; in such cases, holding until the product matures could yield lucrative returns, sometimes reaching the referenced annualized yield of 15%. In bullish market conditions, these products may even terminate early, rewarding investors with interest accrued up until that point.

Conversely, in a bearish market, the landscape shifts entirelyShould the market oscillate aggressively downward, the scenario known as “hit-in” comes into play, potentially devastating the investors’ capital

Nevertheless, even when a hit-in occurs, there are possibilities for recovery, such as experiencing rebounds or not falling below initial prices prior to product maturity, thus mitigating losses.

This inherent complexity of snowball products navigates an intricate dance of risk versus rewardThe successful execution relies on the broker determining precise observation dates to ascertain whether the products hit-in or hit-out, which directly influences the financial outcomes for investorsWith hit-out observation dates generally scheduled monthly and hit-in dates occurring more frequently, market conditions play a crucial role in the profitability of these investments.

However, it’s essential to recognize that snowball products are not suited for all investors; one must be classified as a qualified investor due to the high-risk nature of these instrumentsDelving deeper, the regulatory framework underscores a need for brokerages to maintain mindful practices surrounding client appropriateness while adhering to specified risk thresholds

Past patterns had allowed brokerages to capitalize on Delta-neutral hedging strategies, but market instability has increasingly complicated the landscape.

Returning to our opening scenario where the leverage was amplified to four times, the risks intensify dramaticallyThe allure of potentially achieving an annualized yield of 52% via leveraging becomes overshadowed by the stark reality that incurring losses beyond specific thresholds, such as a 25% decline, could result in the complete erosion of the original investment capitalConsequently, while introducing additional potential for returns, leveraging snowball products presents an existential threat to capital preservation.

In summary, the risks associated with snowball products have heightened, yet they remain intricately tied to the overall movements within index futures rather than impacting the actual spot market directly