Structured Products' Risk Intensifies with Single Stock Volatility - The Case of the ARKK ETF

With brokerage firms and banks increasingly trending toward sales of structured products tied to a single stock, the risk of investing in this style of derivative products increases due to stock volatility, especially in the case of linked stocks which make lofty promises and experience significant price fluctuations.

Take the case of ARK Innovation (symbol ARKK), an exchange-traded fund (ETF) which has experienced significant volatility over the past year. Because ARKK itself is an ETF, it already carries with it risk simply by being a complex product tied to a certain index or basket of securities (in this case, hand-picked tech sector stocks). Now, take this already-risky ETF and build a new structured product tied only to that ETF and the risk is exponentially compounded.

The risk intensifies because structured products may only pay out under certain conditions, such as the underlying stock's price staying at or above a certain value or suspending interest or other payments if the stock drops below a minimum threshold. When a stock itself is risky and experiences frequent volatility, the likelihood of investor losses increases due to the greater likelihood of the stock price passing through these threshold values.

ARKK itself doubled in value in 2020, but the bubble eventually shrunk, and dramatically so, leaving investors who purchased ARKK since that time to suffer significant losses as ARKK's price crashed through the referenced price.

According to the Barron's article "Cathie Wood’s ARKK Investors Missed the Big Gains and Ate Huge Losses, New Data Show," investors saw results "far worse" than ARKK's actual performance, which averaged just under +10% per year. Meanwhile, investors have seen a -14% return to date in 2024.

ARKK itself invests in the technology sector, with stock names like Roku, Roblox and Zoom, and whose losses contributed to an especially volatile time for ARKK and losses for its investors. The plunge is fairly logical, as ARKK largely invests in tech that may have been extremely in-demand during the COVID-19 pandemic in 2020 and 2021—such as Zoom or Teladoc Health—but are less valuable in 2024 than they were several years prior (not to say Zoom or Teladoc aren't still in demand, but that relative to 2020, they are less popular).

According to Morningstar analyst Jeffrey Ptak, investors who invested in a standard S&P 500 index fund would have earned returns of 15% a year over the last five years, while ARK investors lost about 17% per year, leading the analyst to describe ARKK as "a major fail."