Structured notes are particularly valuable for concentrated equity holders because they allow investors to manage risk without selling shares. Let’s explore the most relevant types.

1. Principal-Protected Notes (PPNs): Downside Safety With Partial Upside

How They Work: A principal-protected note ensures that, at maturity (often 3–7 years), the investor receives at least 100% of their original investment — regardless of how the underlying stock or index performs. In return, the investor participates in a portion (e.g., 50%–90%) of the upside.

Example:

• You invest $1 million in a 5-year PPN linked to your company’s stock.
• At maturity, you receive your $1 million back, plus 75% of any gains.
• If the stock falls 40%, you still receive your original $1 million.
• If the stock doubles, you receive your principal plus 75% of the gain.

Use Case:

• Suitable for executives nearing retirement who prioritize capital preservation but still want upside exposure.
• Ideal for hedging a concentrated position without triggering a sale.

Risks & Considerations:

• Limited upside: Participation rates cap potential returns.
• Credit risk: The bank’s solvency determines payout — if the issuer defaults, principal could be at risk.
• Illiquidity: Most PPNs are held to maturity; early exit can be costly or impossible.

2. Buffered Notes: Partial Protection, Enhanced Participation

Buffered notes offer partial downside protection — typically 10%–30% — while providing higher upside participation compared to PPNs.

Example:

• A 3-year buffered note offers 20% downside protection and 110% upside participation.
• If the stock falls 15%, you lose nothing.
• If it drops 30%, you only lose 10%.
• If it gains 40%, you receive 44%.

Use Case:

• Useful when you’re concerned about moderate volatility but still want to maximize upside.
• Popular as a supplement to a concentrated position rather than a full hedge.

Risks & Considerations:

• Protection is limited. Severe declines beyond the buffer still impact returns.
• Complex payoff structures can make performance difficult to predict.
• Liquidity and credit risk remain factors.

3. Yield-Enhancement Notes: Generating Income From Concentrated Holdings

If your company stock doesn’t pay dividends, structured notes can generate yield by selling downside exposure — often through embedded short puts.

Example:

• A reverse convertible note pays a 10% annual coupon.
• If the stock remains above a certain level, you receive the coupon and your principal back.
• If it falls below a threshold, you may receive shares instead of cash, possibly at a loss.

Use Case:

• Ideal for investors who expect the stock to trade in a range.
• Can provide cash flow for diversification or liquidity needs without selling shares.

Risks & Considerations:

• Potential to receive stock at a lower price if markets decline.
• Coupon payments are typically taxed as ordinary income.
• Risk–return trade-off must be carefully assessed.

Part III: Derivatives — Precision Tools for Risk Management

While structured notes offer packaged solutions, derivatives — such as options, forwards, and swaps — provide more flexible, customizable ways to manage risk around concentrated positions. They can be tailored to match your risk tolerance, liquidity needs, and tax objectives.

1. Protective Puts: Downside Insurance Without Selling

A protective put is a classic options strategy that acts like insurance for your stock. You pay a premium for the right — but not the obligation — to sell shares at a predetermined price (the strike) within a certain period.

Example:

• You own 100,000 shares at $100.
• You buy a 12-month $90 put for $5 per share.
• If the stock drops to $60, you can still sell at $90.
• If it rises to $150, the put expires worthless — but you keep the upside.

Pros:

• Simple, effective downside protection.
• No sale, so no capital gains tax triggered.
• Retain full upside potential.

Cons:

• Premium cost can be high, especially for volatile stocks.
• Options expire — protection is temporary and must be renewed.

2. Collars: Cost-Neutral Risk Management

A collar pairs a protective put with a covered call — selling a call option to offset the cost of buying the put. The trade-off: you cap your upside potential.

Example:

• You buy a $90 put and sell a $120 call.
• Downside is protected below $90.
• Upside is capped above $120.
• Cost is minimal or zero.

Use Case:

• Excellent for executives who value downside protection over unlimited upside.
• Often used as a medium-term strategy before a liquidity event.

Risks & Considerations:

• Upside cap means you may miss out on significant gains.
• Tax implications if options are structured improperly (e.g., constructive sale risk).
• Requires careful strike selection and timing.

3. Prepaid Variable Forwards (PVFs): Liquidity + Hedging + Tax Deferral

A prepaid variable forward is an agreement to deliver a variable number of shares (or cash equivalent) in the future in exchange for an upfront cash payment today — typically 75%–90% of the stock’s current value.

Example:

• You pledge 100,000 shares worth $10 million.
• You receive $8.5 million today.
• At maturity (3–5 years):

• If stock < $85: Deliver full 100,000 shares.
• If stock $85–$130: Deliver fewer shares.
• If stock > $130: Deliver shares worth $13 million.

Pros:

• Immediate liquidity without selling.
• Built-in downside protection and partial upside.
• Tax deferral until settlement.

Cons:

• Upside capped above the contract ceiling.
• Constructive sale risk if structured incorrectly.
• Counterparty risk with the financial institution.

4. Equity Swaps and Forwards: Institutional-Grade Risk Transfer

For ultra-high-net-worth investors, equity swaps and custom forward contracts offer institutional-grade flexibility. These contracts allow you to exchange future stock returns for a fixed or floating return — effectively offloading volatility.

Example:

• You agree to pay the total return on your company stock to a counterparty.
• In exchange, they pay you LIBOR + 2%.
• If the stock collapses, you’ve locked in a predictable return.

Risks:

• Counterparty default.
• Complexity and negotiation required.
• Potential constructive sale treatment.

Part IV: Comprehensive Risk Considerations

Structured notes and derivatives are powerful — but they’re not without complexity and risk. Understanding these factors is critical before implementation.

1. Credit Risk

Structured notes and many derivative contracts are obligations of the issuing bank or counterparty. If the issuer defaults, your principal and returns could be at risk. Always assess the credit quality and diversification of counterparties.

2. Constructive Sale Rules

The IRS may treat certain derivative strategies as a constructive sale if they eliminate substantially all risk and reward of ownership — triggering immediate capital gains tax. This often arises with collars, forwards, and swaps. Proper structuring (e.g., partial hedges, wider collars) helps avoid this.

3. Liquidity Risk

Many structured notes are illiquid and cannot be sold before maturity. Similarly, custom derivative contracts may lack secondary markets. Ensure your liquidity needs align with the strategy’s timeline.

4. Opportunity Cost

Some strategies — particularly collars and PVFs — cap upside potential. In a sharply rising market, opportunity cost can be significant.

5. Complexity and Transparency

Structured products and derivatives often have complex terms and payoff structures. Lack of transparency can lead to misunderstanding risk exposures. Work with experienced advisors who can model various scenarios and outcomes.

6. Legal, Compliance, and Insider Restrictions

Corporate policies, insider trading laws, and SEC reporting requirements may limit your ability to execute certain strategies. Always coordinate with legal counsel and compliance teams before implementation.

7. Cost and Tax Efficiency

• Options premiums, structuring fees, and spreads can erode returns.
• Some strategies (like yield-enhancement notes) generate ordinary income.
• Tax deferral strategies must be carefully planned to align with future tax environments.

Part V: Strategic Combinations and Real-World Applications

The most effective plans often combine multiple tools into a coordinated strategy, tailored to an investor’s goals, risk tolerance, liquidity needs, and time horizon.

Example 1: Risk Management + Liquidity

• Protective Put: Buy near-term downside protection.
• PVF: Monetize a portion of shares for liquidity and diversification.
• Exchange Fund: Use PVF proceeds to build a diversified portfolio.

Result: Reduced volatility, increased diversification, and deferred taxes.

Example 2: Yield Enhancement + Estate Planning

• Reverse Convertible Note: Generate income from concentrated stock.
• Collar: Limit downside risk cost-effectively.
• Charitable Remainder Trust: Use shares to fund a tax-advantaged estate plan.

Result: Cash flow generation, risk reduction, and tax-efficient wealth transfer.

Example 3: Long-Term Hedging + Upside Participation

• Equity Swap: Transfer near-term risk to a counterparty.
• Buffered Structured Note: Capture enhanced upside with partial protection.
• GRAT or ILIT: Transfer future appreciation out of the estate.

Result: Multi-layered strategy that protects, grows, and transfers wealth.

Final Thoughts: Control Risk Without Losing Opportunity

For decades, concentrated equity was a “binary problem”: sell and diversify — or stay concentrated and accept the risk. Structured notes and derivatives have changed that equation. They offer a middle ground — a way to retain ownership, manage volatility, unlock liquidity, and optimize tax outcomes — all without the immediate cost of a sale.

However, these tools are complex, often illiquid, and carry unique risks. They require deep coordination among your financial advisor, tax professional, attorney, and corporate counsel. But when structured correctly, they can transform concentration from a vulnerability into a strategic advantage — one that supports long-term wealth creation, risk management, and legacy planning.