What are bear notes?

A bear note is a special type of investment that some people buy because they think it will make them more money. The value of the bear note goes up when the price or value of something else goes down. That “something else” is called the reference asset.

The reference asset for a bear note can be almost anything that has a price or value that changes over time. Some common reference assets are stocks, bonds, gold, oil, or even measures of the whole stock market.

When you buy a bear note, you are betting that the reference asset will lose value. If it does go down in price, your bear note becomes more valuable and you make money. The more the reference asset drops, the more money you can make from your bear note.

How bear notes work

Bear notes have two main features that determine how much money you can make:

1. The participation rate
2. The coupon

The participation rate decides how much of the reference asset’s decline you get to participate in or benefit from. For example, if a bear note has a 200% participation rate and the reference asset falls 10%, your bear note would go up in value by 20% (200% of 10%). A higher participation rate means you make more money if the reference asset goes down.

The coupon is extra interest you can earn on top of your gains from the participation rate. Not all bear notes pay a coupon. For those that do, the coupon is usually higher when the reference asset is doing badly. So you get rewarded with more interest in bad times.

Risks of bear notes

Bear notes can make you good money if you predict correctly, but they also have big risks:

1. The reference asset might not go down. If it stays flat or goes up instead, you could lose most or all of your investment. There’s no guarantee the asset will drop in value.
2. Bear notes are complex. It can be hard to understand all the fine print about participation rates, coupons, and other special conditions. You might not realize what you’re getting into.
3. They are not very “liquid”. Once you buy a bear note, it can be hard to sell it to somebody else later if you change your mind or need the money for something else. You might have to sell it for a much lower price.
4. The company that sells you the bear note might go bankrupt. If that happens, you could lose all your money even if you were right about the reference asset losing value.

Because of these risks, bear notes are not right for everyone. They are usually only sold to “accredited investors”. Those are people who have a lot of money and experience investing.

Real life examples

To help understand how bear notes work in the real world, let’s look at a couple examples.

Example 1: Oil Bear Note

Imagine an oil bear note with a 3-year term, 250% participation rate, no coupon, and $100 principal. The reference asset is the price of a barrel of oil.

You think oil prices are going to fall, so you buy this bear note. At the end of the 3 years:

• If oil fell 20%, your bear note would be worth $150 ($100 x [1 + (20% x 250%)])
• If oil fell 50%, your bear note would be worth $225 ($100 x [1 + (50% x 250%)])
• If oil stayed flat, you would only get your $100 back
• If oil rose 20%, you would lose money and get back only $50 ($100 x [1 – (20% x 250%)])

So this oil bear note amplifies your gains if you’re right about falling oil prices, but also amplifies your losses if you’re wrong.

Example 2: S&P 500 Bear Note

Now imagine an S&P 500 bear note with a 1-year term, 300% participation rate, a 10% coupon, and $1000 principal. The reference asset is the level of the S&P 500 stock market index.

You think the stock market is about to crash, so you buy this bear note. At the end of the 1 year:

• If the S&P 500 fell 20%, your bear note would be worth $1700 ($1000 x [1 + (20% x 300%)] + 10% coupon)
• If the S&P 500 fell 40%, your bear note would be worth $2300 ($1000 x [1 + (40% x 300%)] + 10% coupon)
• If the S&P 500 stayed flat, you would get $1100 back ($1000 + 10% coupon)
• If the S&P 500 rose 10%, you would lose money but still get $700 back ($1000 x [1 – (10% x 300%)] + 10% coupon)

With this S&P 500 bear note, you could triple your money if the market crashes hard. But if stocks go up instead, you’ll lose money, though the coupon provides a small buffer.

Considerations before investing

If you’re thinking about investing in bear notes, here are some things to consider:

1. Only invest money you can afford to lose. Bear notes have high risk.
2. Thoroughly research the specific terms of any bear note before buying. Understand the participation rate, coupon (if any), term length, reference asset, and any other special conditions.
3. Think carefully about what might happen to the reference asset. Is it really likely to go down? By how much? What could cause it to go up instead?
4. Consider your overall investment mix. Bear notes can help diversify but shouldn’t be your only holding.
5. Understand the tax implications. Gains on bear notes are usually taxed as ordinary income, not lower-rate capital gains.
6. Watch out for high fees. The companies that create bear notes often charge high upfront or annual fees that eat into your returns.
7. Have an exit plan. Know when you’ll want to sell the bear note, to whom, and how that process works. Don’t get stuck holding it longer than you want.
8. Read the fine print about “call risk”. Some bear notes let the issuer “call” (cancel and pay off) the note early in certain situations. That can cap your gain.

Where to buy bear notes

If you’re an accredited investor and want to buy bear notes, you have a few options:

1. Full service brokers: Some high-end brokerage firms that cater to wealthy clients offer bear notes. They can help select and purchase them.
2. Private banks: Many banks have special divisions that serve high net worth individuals. They often have bear notes available.
3. Specialty structured product brokers: There are specialty brokers that only deal with structured products like bear notes. They tend to have the widest selection.
4. Some online brokers: A few of the major online brokers have started offering bear notes to their accredited investor clients.

Whoever you buy through, make sure they are properly licensed and regulated in your country/state. Bear notes are complex enough without having to worry if the seller is shady too!