Understanding structured products

How structured products work

Structured products blend features from bonds and derivatives to create specific outcomes based on your investment objectives, like mitigating losses or boosting gains. They also offer access to investment strategies you can’t get from traditional stocks or bonds.

Every structured product has two main parts:

• The bond piece: The “debt instrument” provides potential downside protection — the issuer’s promise to return some or all of your money at maturity, as long as they’re still solvent. This is often structured as a zero-coupon bond, which means it doesn’t pay interest along the way but returns a lump sum at the end. Some products are designed to fully protect your initial investment. Others don’t protect it at all. It depends entirely on the terms.
• The options piece: This is the “derivative component” that creates the potential upside — it links your return to how the underlying asset performs.

The balance between these two pieces determines what you get: how much risk, how much potential reward. More downside protection usually means less upside potential, and vice versa.

What assets are structured products tied to?

Structured products can track a wide range of assets — stocks, ETFs, commodities, interest rates, or currencies. Some are designed to base returns on the best- or worst-performing asset in a group, or adjust gains and losses based on market conditions. 

Each asset brings a different mix of risk and potential return. For example, a note tied to one stock can offer bigger potential gains but also carries more risk if that stock drops.

The role of wholesalers

Wholesalers sit between issuers and advisors, translating complex product designs into real-world applications. They break down payoff diagrams and offering documents, provide scenario analysis tools to test how products behave under different market conditions, and help match specific structures to client goals.

Good wholesalers also offer transparency around pricing, fees, and estimated values — critical information that isn’t always easy to find on your own. Education is also a big part of their role. Many wholesalers run training sessions, publish explainer materials, and field questions from advisors daily, giving them insight into what actually trips people up.

If you’re new to structured products or want to deepen your understanding, building relationships with knowledgeable wholesalers is one of the best ways to navigate the learning curve.

Principal-protected notes (PPNs)

These notes guarantee your initial investment back at maturity (assuming the issuer is solvent), while giving you a chance to capture some market gains. They work by combining a bond that covers your principal with options tied to an index or stock basket.

Example

You invest $10,000 in a three-year PPN tied to the S&P 500. The note offers 60% participation in gains, which means you’ll earn 60% of whatever the S&P 500 gains over those three years — and you’ll get your $10,000 back at the end, as long as the issuer stays solvent.

• If the S&P 500 rises 30% over three years: You get your $10,000 back plus 60% of that 30% gain. That’s $10,000 + $1,800 = $11,800.
• If the S&P 500 falls 20%: You still get your full $10,000 back at maturity, less any fees (more on that later).

Enhanced participation notes

These notes amplify your gains when markets rise — often giving you 125% to 200% of the market’s return — but in exchange, you give up downside protection, and your gains are typically capped. You’ll need to hold until maturity and bear the risk that the issuer could default.

Example

You invest $10,000 in a note that offers 150% participation in S&P 500 gains, with a cap of 30%.

• If the S&P 500 rises 15% over the term: You get 150% of that gain, equivalent to a 22.5% return. Your $10,000 becomes $12,250.
• If the S&P 500 rises 25%: You get 150% of that, which is equivalent to a 37.5% return — but the cap limits you to 30%. Your $10,000 becomes $13,000.
• If the S&P 500 falls 15%: You lose that full 15%. Your $10,000 becomes $8,500.

Buffered notes

These notes offer partial downside protection — called a “buffer” — while capping your upside. For instance, a note might absorb the first 10% of losses but limit your gains to 20%. You need to hold until maturity, and the payout depends on whether the issuer stays solvent.

Example

You invest $10,000 in a one-year note with a 10% buffer and 20% cap, tracking the S&P 500. Here’s what happens in different scenarios:

• Market falls 8%: The buffer absorbs the loss. You get your full $10,000 back.
• Market falls 15%: You lose the 5% beyond the buffer. You get $9,500 back.
• Market rises 10%: You capture the full gain. You get $11,000 back.
• Market rises 25%: You’re capped at 20%. You get $12,000 back.

Income notes

Income notes are investments designed to provide periodic interest payments, but those payments depend on market performance. On each review date — typically monthly or quarterly — you receive a coupon only if the underlying investments stay above a preset “coupon barrier.” If they fall below that level, the payment for that period is skipped and not made up later.

You continue to receive these contingent coupons as long as the underlying assets remain above the barrier, and the note typically runs until maturity unless it includes a feature that allows it to be called early. At maturity, your principal is protected only if the underlying investments stay above a separate “principal barrier.” Otherwise, you take losses in proportion to the decline.

Example

You invest in a note linked to the S&P 500, Russell 2000, Nasdaq-100, and Dow Jones that targets a 9% annualized coupon. Each month, if all indexes are at or above 75% of their initial levels, you receive the coupon. If any index falls below that barrier, that month’s coupon is skipped. At maturity, if all indexes stay at or above a 60% principal barrier, you get the full principal back. If even one finishes below that level, your loss mirrors the decline of the weakest index.

Market-linked CDs

These are certificates of deposit whose returns depend on the performance of an underlying index, like the S&P 500 — but with one key difference: They’re typically FDIC-insured up to $250,000 per depositor, per bank. That means your principal is protected even if the issuing bank fails, though the market-linked portion of the return isn’t guaranteed.

Example

You invest $10,000 in a five-year market-linked CD tied to the S&P 500. The CD offers 50% participation in any upside, with full principal protection.

• If the S&P 500 rises 20%: You earn half that gain — a 10% return. Your $10,000 becomes $11,000.
• If the S&P 500 falls 15%: You get your full $10,000 back at maturity.
• In the unlikely event that the bank fails: The FDIC covers your principal, but not any accrued interest or potential market gains above the insured limit.

Principal isn’t always guaranteed

These notes are obligations of the issuing bank, which means their value depends entirely on whether that bank stays solvent. If the issuer defaults, any principal protection becomes worthless.

Example

During the 2008 financial crisis, investors who held structured notes from Lehman Brothers lost their money when the firm went bankrupt. The loss didn’t happen because the investments inside the notes performed badly — it happened because Lehman itself couldn’t pay what it had promised. The protection built into the notes only worked as long as Lehman stayed solvent. When the company collapsed, that protection disappeared, and investors’ principal was lost.

It’s worth noting that structured products generally don’t carry FDIC insurance. The exception: Certain market-linked CDs may qualify for FDIC protection up to $250,000 per account owner, per institution — but this applies only to specific CD structures, not to structured notes broadly.

It’s hard to exit early

Structured notes aren’t designed for flexibility. Secondary markets are thin, which means there’s little opportunity to sell notes before they mature, like you might with stocks or bonds. Issuers also aren’t required to help you get out early.

Getting out is possible, but it will also cost you. For example, let’s say an investor needs to exit a five-year note after two years. They might lose a percentage on the current value of the note — even if the underlying asset is performing well and the note would return full principal at maturity. 

Fees are hidden in the price

Structured products don’t disclose fees the way mutual funds do. Instead, costs are baked into the structure itself. A $1,000 note might have an actual starting value of only $950–$970 — that $30 to $50 gap represents the issuer’s fees, typically 3–5% of your investment.

Small details make a big difference

Tiny structural variations can completely change how a note performs, like a 10% buffer versus a 15% one, monthly performance checks versus annual, or different call triggers. These details determine whether a product delivers what you expect or falls short.

Tax considerations

Most structured notes are taxed as contingent payment debt instruments (CPDIs), which means investors may owe taxes annually on imputed income — even if no cash payments are made during the term.

This creates two key implications for after-tax returns:

• Phantom income: Investors can be taxed each year on projected earnings, even when the note doesn’t actually pay interest. For example, a note expected to earn 6% annually could trigger annual tax liability on that 6%, even if the final return ends up lower.
• Ordinary income rates: Gains are usually taxed as ordinary income — up to 37% for high earners — rather than at the lower long-term capital gains rate of 20%.

That difference can meaningfully change outcomes. A structured note returning 12% pre-tax nets about 7.6% after tax at the 37% rate, while a comparable equity investment returning 10% nets roughly 8% after long-term capital gains treatment. In other words, the nominally higher pre-tax return can translate to a lower after-tax result.