CD offers hedge against market drop


March 11, 1994|By David Conn | David Conn,Staff Writer

Buy stocks that go up, someone famous once advised, and if they don't go up, don't buy them.

In a sense, that's exactly what options traders do. For instance, if you wanted the potential gains of the Standard & Poor's 500 Stock Index, but didn't want to lose your shirt in case of another Black Monday, you could protect yourself with a "put option."

For a fee, called the premium, a put option gives you the right -- but not the obligation -- to sell a security in the future at a price you specify today. Typical put options last 30, 60 or 90 days.

So, you could buy both a basket of S&P 500 stocks and an S&P 500 put option. If the market rises, you simply let the option contract expire unused. If the S&P falls, you exercise the option when it comes due and sell the stocks at the earlier, higher price, and you've broken even, except for the premium.

This strategy has been introduced by the First National Bank of Maryland. Its new Mint CD, according to ads launched this month, promise "stock market returns . . . FDIC insured."

First National is the first in this market to start selling a stock market-linked deposit product (banks in other markets pioneered With the Mint CD, a federally insured certificate of deposit will pay a few percentage points less than the gain of the S&P 500 Index.

If the S&P falls, the principal is protected; all that's lost is the interest that would have been earned if the money had been invested in a normal CD, the bank's version of an option premium. The bank, incidentally, will use the Mint CD deposits to buy its own options, probably for less than it would cost to pay interest to normal CD-holders.

For instance, a three-year $10,000 Mint CD opened in January 1991 would have earned about $3,870, or roughly 12.8 percent a year. The S&P gained 13.3 percent a year during the same period, or 16.6 percent with reinvested dividends.

Of course, if the market had fallen during the three-year period -- as some fear it may do now -- the Mint CD-holder's $10,000 would have been returned, but without the roughly 3.5 percent interest a normal CD would have paid at the time, or about $1,087. That cost (the "option premium") is a bit higher these days because three-year CD rates are up to more than 4.25 percent.

The Mint CD has a $2,000 minimum investment, and for now it's available only for tax-deferred retirement vehicles, such as IRAs and 401(k) plans. The bank hopes to offer it for taxable investments soon, according to Senior Vice President Joan Gillespie.

"This gives us the opportunity to gain some new customers, because we happen to be the only one in the marketplace who's doing this," Ms. Gillespie said. "Hopefully if this is the first relationship, we'd hope to gain their core relationship as well," such as checking and savings accounts.

Since this product is called a certificate of deposit, and is sold by a bank, one concern has been raised by competitors. "I think it's misleading to certain investors who do not understand the difference between savings and investing," says Terry Woulfe, senior portfolio manager at Baltimore's Oak Tree Portfolio Management.

"I just see a lot of elderly people, or unsophisticated investors, being brought to this because it's under the auspices of a banking institution," Mr. Woulfe says. "As a product it seems fine, but it seems like a wolf in sheep's clothing."

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