There has been some heated discussions between an American IB and a client that bought an option on CPPI to a European bank back in April 2005. The former spent a lot of time pitching the client that dealt with the European Bank and the main issue on this was the fact that the Product sold was an Option on CPPI instead of a CPPI.IMO an option on CPPI has a different price throughout its life thanks to option's price, then buybacks have different prices.Apart from this, some structurers told me that operational management costs of these 2 are different, and human intervention is greater in of them....What one is easier to do in terms of minimum size ? 5 Mln EUR, 10 Mln EUR ?Any hindsight ?

Hi Wildbill,As far as I know CPPIs generally have rules that determine when to buy and when to sell, and then give a payout dependent on the price of these filled orders. Actual buying and selling occurs. Its similar to hedging a short vanilla option struck at 65 by buying 100% delta when price goes up through 65 and selling 100% delta when price goes down through 65.Options on CPPI generally give the payout at maturity that is dependent on the theoretical payout of a CPPI strategy. So no exact (to CPPI strategy) buying and selling has to occur but tracking of what the buys and sells would have occured needs to be tracked for the final payout. This is less administratively burdensome.Also, there is another catch. Assuming there is no slippage then the CPPI strategy is more expensive than the option. CPPI basically has bands that kick in buying and selling at discreet periods. This has the effect of buying high and selling low. This is similar to my analogy above of buying and selling the 100% delta as the spot price goes through 65 except you actual sell 100% delta at 64 and buy 100% at 66. If I were an investor then I would never go into a CPPI strategy purely for this reason. The volatility of the path will detemine how much buying high and selling low you end up doing. Similarly if you were hedging a vanilla option you could delta hedge by look at the change in PV of expect payout with change in underlying price now. This is something the BS equations give us the ability to do hence the continuous delta.Aside, this also explains why hedge funds under CPPI are popular. They are considered low volatility but a CPPI will let the investor err on the side of caution in case evrything goes belly up (CPPI seller takes the gap risk usually).RegardsPabo

the value of the two usually differs during the life as well as at maturity. oCPPI (option based cppi) has a participation rate on the cppi portfolio, so at maturity the difference will be between the performance of the cppi portfolio and the participation rate. During the life of the product there are two big factors which will contribute to the pricing difference: 1) oCPPI value is dependent on the delta of the option, where a CPPI portfolio doesn't have a delta. 2) oCPPI structures consist of a zero coupon note & call option, so it will be sensative to the interest rate curve, while the market-to-market of CPPI structures are neutral to interest rate changes. From an ibanks perspecitve oCPPI is easier to manage as there is some flexibility in the delta hedging, while the traditional CPPI has strict rules based hedging. Fees are also better for oCPPI as both a 'risk management fee' is taken as well as a spread on the implied vols on the option.from an investors perspective traditional CPPI usually makes more sense, since the 'advantages' of oCPPI are usually purely psychological, such as a minimum exposre, etc (but havnig a minimum exposure if 10% is pretty worthless, as a product that falls this low will never recover)

Both answers are pretty useful, however I have some questions : QuoteAs far as I know CPPIs generally have rules that determine when to buy and when to sell, and then give a payout dependent on the price of these filled orders. Actual buying and selling occursSo that is where the Human Intervention is actually.... which can be a sales argument Quoteso it will be sensative to the interest rate curve, while the market-to-market of CPPI structures are neutral to interest rate changes. In fact I have always been thinking that first generation CPPI had a Threshold which was sensitive to interest rates. THR(t) was the present value of a zero coupon bond maturing on the Termination Date. Some banks added may be in Option on CPPI structures a Fixed Threshold starting at a certain level (like 85%) and increasing linearly....So is the fixed or variable nature of the Threshold the difference between a pure CPPI and an Option on CPPI ?QuoteFees are also better for oCPPI as both a 'risk management fee' is taken as well as a spread on the implied vols on the optionI had the interview and one guy told me that the Fees structures was different (the Drag Factor). Since it s like a Dividend on the underlying, so increasing the fees, makes the option cheaper, just like increasing the dividends on the underlying asset in the basic option theory.

Hi All,the apparition on CPPI Options came first wtih the need from some client to have minimum participation rate, stragiuht protection curve on CPPIs, etc.Basically, the CPPI Option advantage is that, building a simple structure = Zero Coupon + Call Option on CPPI, you get the exact pay off of CPPI at maturity, with the possibility to eliminate some gap risk thanks to the bought zero coupon swap. To one extent, CPPI Option allows the investor to get very exotic pay off at matuirty (minimum participation, protection cruves best off, etc.) wich are impossible under pure CCPI management. As faras I am concerned, I consider CPPI as easyer to manage, as it simply follows allocation rules, instead of managing the Call Option, wich is pretty difficult when it come to basket of hedge fudns for instance...question of point of views...

Quotewith the possibility to eliminate some gap risk thanks to the bought zero coupon swap. 1/ How does this work ? I don't see the difference between the risk in both structures2/ I did not know that the minimum exposure to the underlying was not possible to do on a straight CPPI. I have looked up on internet and have not really found some papers describing the exact construction of a CPPI or an Option on CPPI Structure in terms of parameters, etc. If anyone has some, I d be interested to read them. I found this ARticle on internet about the DPI which is a CPPI with a variable multiplier. The Authors are speaknig about the possibility to do an Interest Rate Swap for the Threshold line ? Is is really so easy , how do you manage your exposition in terms of nominal if you need to increase the non-risky asset compinent for example ?

I must admit I have heard the term "option on CPPI" thrown around, and when I asked someone about it they said it wasn't a real option, just a sort of a fake that is useful for structuring.I know that true options on CPPI, such as max(0, CPPI_GTEED_AT_100 - 120) exist and can be priced. But that is tricky - you would normally have to use "unconstrained CPPI" as the underlying, so that there is no limit on the leverage available to the underlying CPPI. In that case an analytical result exists for the final value of the CPPI (it is not path dependent).But it sounds like this "option" is simply equal to, using the same notation, CPPI_GTEED_AT_100 - 100.So in other words, say your underlying CPPI has a floor at 85, a multiple of 4 and the portfolio is currently worth 100, you would have 60% in equity and 40% in zeroes.Let ZCB = NPV of a zero coupon bond.The option version would have 60% in equity and (40%-ZCB) in zeroes. The price of the "option" is always 100% - ZCB (ignoring gap hedge cost and PNL of course).You can then add in a true zero coupon bond from a real issuer (like an MTN desk) and attach your own "option" on CPPI.To create a CPPI with a minimum equity exposure like 10%, you simply use a zero coupon bond that pays back 100%, spend 10% on stock, and spend the rest of the money to buy less than 100% of a "CPPI "option". Is this the true picture?

This is a spreadsheet with a simple pricing model. It has a bug with it (because its only in Excel) but gives the general idea.RegardsPabo Spreadsheet updated at 11:24 (found an error) apologies.

pabo - thanks for uploading that.in other words, the commonly used expressed "an option on CPPI" refers to the NPV of "CPPI_GTEED_AT_100 - 100", as i described below.is that right?interesting way you created a loop! i tend to use VBA for that.

hi erstwhile,i found a couple of more errors... i only pulled the sheet together this morning.yep - you right. option is on MAX (CPPI - strike, 0) where strike is usually gteed levelits been a couple of years since i worked in equities on this but i remember that a stochastic zc bond affected the price quite a bit. i'll try to put that in a spreadsheet as well.i think that the circular reference works well but its probably not as explicit in showing the workings as a vb loop. also if parameters changes then it best to run once to clean the cppi paths.regardspabo

Awrite. I think the main difference between the two are Added features on Option on CPPI : Fixed Threshold, Min Exposure, Asianing in the End Hedging has impact on final performance of CPPI Index on ctr8 CPPI, whereas it has not on Option on CPPI. so I have found out (after the others may be) that the real action now among asset managers like SGAM AI, is the Dynamic Portfolio Index. which is basically a CPPI but where the ASset Manager plays on the Multiplier, making it moves from 3 to 6 for example. A good one, should even not touch the Threshold in the product.

greghm - i thought that we established that:option on CPPI = CPPI minus "zero coupon bond paying the final floor value"no?the hedging action thru the trade is exactly the same for both, apart from the one zcb.if you can do an "asian end" CPPI option, then that would be based on an "asian end" CPPI, right?i mean i think it's kind of a trivial difference from a quant standpoint, but significantly more flexible from a structuring standpoint.or are you understanding something different?

Forgot to answer.... everything is correct.This thread seems to be the most complete on Difference between CPPI and Option on CPPICould we speak about the secondary market differences for these two structures ?Since the latter is option based, we can speculate than someone asking for a buyback of a few % of the notionnal amount, will have less realized value on the oCPPI, right ?

* Coming back a little to "Options on CPPI". I'd say that some structurer/sales teams label "option on cppi" a CPPI with a min exposure in the risky asset, or a simple call on the CPPI. But a call on a cppi more or less comes back to the same pay off as the CPPI if the underlying trading rules are identical. So as for more "human intervention"...Options on CPPI as such are really best of CPPI, in which a client wants a participation in the best of asian, american and european markets, with some insurance. The writer would then sell him a best of 3 (in this case), with say some intermediary coupons based on the performance of the best of these. That would really be an option on CPPI, and having seen many quants break their teeth on a semi closed form solution, I'd argue that these are not simple products and then that'd justify extra management fees. Also, the trading events are not always related to a rebalance. Take the example of the same best of 3, in a case when on of the 3 markets outperforms the others a lot. Then cross gamma would drag your position way long in the 2 worse and short in the best one. Hence even if you did not trigger any rebalance in the effective weights, you might need to trade all 3 risky assets in order to hedge properly, which can be really costly.* Secondary marketYou are right greghm, as far as this is concerned, on a "vanilla" CPPI, any secondary market trade could exactly match the performance (provided your underlying is liquid enough - else you might charge a bit on buybacks if for instance it is a HF underlying and you are left of long for 2 months before being able to hedge). While in the case of the option (the one I mentionned), at any point in time, correlation between underlyings and different weights while the underlying CPPIs algorithms are run means that paying the actual best of is hard to do as the best of payoff is only guaranteed to be hedged at a coupon date or at maturity, while during the life of the product, the ranks can swing so much that it is hard to tell. But usually in the case of best of's, the initial termsheet specifies a higher bid-ask spread to cover for that risk, which in the end comes back to a reduction of the participation in the option.