Introduction
ELN stands for Equity-Linked Note. An ELN is a structured note that combines debt with equity-linked assets. These assets include shares, stocks, bonds, high-paying baskets of securities, and currencies to name a few.
ELNs are highly dynamic for investors because these notes offer flexibility in payouts and give investors overseesable insights into the equity markets.
At the same time, most ELNs provide a reasonable level of downside or capital protection for investors. In other words, you are more likely to receive your principal wallet back as long as the stock markets do not crash very badly.
On this parlance, let us discover the core points of differences covering ELN Knock In Vs ELN Knock Out. Shall we get started with the same?
Getting an overview of the activation or deactivation process
An ELN Knock In gets activated only if the underlying equity or index reaches a certain barrier. We call it knock-in barriers in the industry parlance. Therefore, the initial prices or the purchase point values must reach or exceed the knock-in barriers for the stock options to get activated under your ELN knock-in mode.
Whereas, for an ELN knockout, the ELN gets deactivated when the prices of underlying equity or the underlying assets reach the specific knock out levels. In other words, the ELNs expire or get redeemed once the specific knockout barriers are reached.
This is done so that the product issuers get some kind of ceiling protection against further potential income the ELNs make.
The upside potential is therefore capped by product issuers and the principal plus interest gets paid out to investors once the underlying assets reach knock outs.
Performance of underlying assets
For an equity-linked knock in, the performance of underlying assets reach their upside potential only when the knock-in levels are reached for the ELN knock in notes. The investors can therefore enjoy the upscale participation of ELNs as they reach their specific knock in levels from their initial purchase points.
Whereas, for an equity-linked knock out notes, the investors can enjoy the upside potential of linked-in assets as long as the assets do not breach their knock-out barrier levels.
In other words, you can enjoy the upscale potential of ELN assets as long as the final sale points do not reach the activated knock-out levels.
Once the notes reach their knock-out levels the investors lose hold of their income-earning potential as the ELNs expire and their redemption happens along with capital plus interest earnings as made as wireless settlements to retail and institutional investors.
Understand risk profiling between the two
The risk factor is higher for ELN knock-in notes because the payouts or capital wallet redemption would not happen if the underlying assets do not surpass the knock-in levels as have been initiated by product issuing firms.
In other words, the investors may not be able to capitalize on receiving their payouts in terms of receiving coupons and eventually receiving their principal money back unless and until the prices of underlying assets reach the specific knock in barriers that have been set.
Whereas, ELN knock out notes are less riskier as compared to knock in notes mainly because as the purchase or initial points of underlying assets reach their final sale points in terms of achieving their knock out prices, the notes are redeemed. Therefore, investors can get their interest earnings and capital wallet back.
Use case example between both scenarios
Let us have a use-case example of how an ELN knock-in option works.
A- Cost of the ELN Note= $40
B- Knock in activation= 80 percent of underlying asset price which means 80% of $40 which is $ 32
Therefore, only if the value of the note touches $32, the note gets activated and the performance of the stock gets tracked.
Let us have a use-case example of how the knockout option works:
A- Initial Purchase Price of the ELN = $65
B= Knock Out is set at 120% of the initial purchase point which is 65 + 20 percent of 65= $78
Here, if the final sale point of the ELN reaches $78, the notes are knocked out. Which means, the notes get redeemed.
Here, the investor gets the value of the note and the desired interest earnings as agreed upon while these notes were getting curated.
What are the overall features of ELNs?
These are the overall features you have with respect to ELNs. Let us have a run-down into pointers that are connected with the same:
Meaning and Conceptualization
ELNs are structured notes that combine debt and equity-linked assets. You can underlie equity assets like shares, a basket of high-paying stocks, or currencies to name a few.
The debt portion of the note provides an overall protection to the investors capital wallet while the performance of the notes determine the returns of investment you receive on ELNs.
Therefore, this is a type of structured notes for investors who would want a decent protection against their initial principal investment while able to see an upside potential to earn higher returns as the underlying assets perform well in the markets.
Two-layered structural outlay
The ELNs therefore are equipped with a double-layered structural outlay. While you earn interest payouts in the form of fixed or variable coupons, your investment gets downside protection as you have the debt element infused into the notes. Therefore, ELNs combine debt with equity and have a double-layered structure like any other form of structured product.
Fixed and variable payouts on ELNs
If the ELNs are curated with fixed interest payouts, the interest earnings would be calculated every quarter and the earnings get credited to the investor’s account.
However, on a broader spectrum, as ELNs underlie equity-based assets, the performance of these assets determines the potential rates of returns an investor can receive as a payout or coupon option.
The payouts can be variable if the coupons are paid according to the performance of the underlying stocks that the notes are primarily linked with. Therefore, variable payoffs can also be availed for investors.
Customized tenor periods
As ELN is a structured product, you can customize the notes according to the financial obligations you have in mind.
If you want to meet your immediate financial goals such as settling the fees for your son or daughter or buying yourself a brand new car, you can have ELNs tenured for 6 months to 12 months.
You can also fix a rate of interest these notes can garner over a period of one wholesome year and then take out your wallet with interest earnings.
The Bottom Line
ELNs are versatile investment options for those of you who want to grow your portfolios on an exponential scale. You can receive coupons, interest earnings, or dividend payouts as the notes are linked to equity-based assets. However, you must read the offer documents carefully before investing. What are your thoughts on this? Do mention it in the comments below!
Frequently Asked Questions or FAQs
How can you trade knock-out options on ELNs?
Answer: You must strike a deal with your product issuer to incubate knock-out options on your ELNs. Here, the price of the underlying equity must reach knock-out barriers as against the initial purchase prices or what is also known as the strike prices. The notes can then be redeemed. If the initial strike prices fail to reach knock-out barriers, investors continue receiving coupon payouts from the same.
What happens when the notes fail to hit premium profits and touch loss points?
Answer: The strike prices or the initial purchase points must reach knock-in levels for the ELN knock-in assets to get activated inside the investor’s ELN note portfolios. The notes must reach specific barrier limits that have been stated on the disclosure documents. If the notes fall below knock-ins, then they do not trigger inside your wallet.
Can you sell the notes for discounted prices as prices drop?
Answer: Yes, you can sell the instrument to the financial institution you had procured the notes from. Or, you can sell the notes into secondary markets like your stock exchange offices.
What are the two types of markets you find inside stock exchanges?
Answer: There are two types of markets called the bearish and bullish markets that you find inside stock exchanges. Rising prices indicate that the market is trending on a bullish one. On the contrary, falling price markets indicate that this is a bearish market.
