However, they are continuously priced throughout their lifetime and investors do not face early redemption penalties. In addition, bonus trackers can be issued as much shorter-dated instruments where required.

A bonus tracker is a combination product incorporating:

a zero strike Call (or standard tracker)
a barrier option (down-and-out Put)

The tracker simply replicates the performance of an underlying with no
leverage and will expire at the value of the instrument or index it is tracking.

A down-and-out Put is a type of option called a barrier option which ceases to exist when the underlying asset reaches a predetermined level (in our next example, 3000) and is therefore cheaper than a standard option.

Example

Bonus tracker

Issuer:

ABC Bank

Issue date:

January 2005

Expiry date:

January 2010

Bonus Level:

6000

Barrier level:

3000

Underlying asset:

FTSE 100

Conversion ratio:

1000:1

Issue price:

450p

Above is an example of a FTSE 100 bonus tracker with a bonus level of
6000 (which translates to 600p due to the conversion ratio of 1000:1) and a barrier level of 3000. This product is the combination of a zero strike Call (or tracker) and a Put option with a strike of 6000 and a knock out level of
3000.

This means that should the FTSE 100 fall below 3000 at any point during
the five year life of this product, the Put component will ‘knock-out’ leaving
the product as a simple tracker which will track the FTSE 100 index until
expiry. However, if the FTSE 100 doesn’t fall below the barrier level of 3000, the Put option will remain guaranteeing a minimum payout level of 6000 (ie 600p) at expiry regardless of where the FTSE 100 index is at expiry (above the barrier level of 3000).

At maturity

On expiry the FTSE 100 index closes at 4000 having never fallen below
3000 during the five year lifespan of the product. The zero strike Call (or
tracker) has a value of 400p while the Put has a value of 200p (strike price – final index level) giving a total return of 600p.

If, on the other hand, the FTSE 100 had fallen below 3000 at any point
during its lifetime, then the Put option would have ‘knocked out’ and the
total return would simply be that of the zero strike Call (or plain tracker) of
400p.

Should the closing level of the FTSE 100 be above 6000 at expiry (eg 7050), the total return would be that of the zero strike Call (or tracker) of 705p. This is the case even if the barrier level has previously been hit.