A structured note is a bank’s debt obligation wrapped around a derivative payoff and sold to you as a single security with a reassuring name: “principal-protected note,” “buffered return note,” “autocallable.” Mechanically it is the same chassis as the ETN of section “Exchange-Traded Notes (ETNs)” — senior unsecured debt of the issuing bank — with a payoff formula bolted on. The pitch writes itself: equity upside with a floor, or a fat headline coupon with a “buffer” against the first 10% or 20% of losses. The reality is less flattering.
The bank prices the embedded options and pockets a spread before the note ever reaches you — typically 2% to 4% of principal, plus an ongoing drag. None of it appears as a line item, exactly like the payment-for-order-flow markup in section “Market Microstructure and Execution for Larger Orders”.
“Principal protection” is only as good as the bank behind it. Lehman Brothers structured notes were marketed as capital-protected; holders became unsecured creditors in 2008 and recovered cents on the dollar.
There is no real secondary market. If you need out before maturity, you sell back to the issuer at a discretionary mark set on terms that favor the issuer.
The IRS generally treats market-linked notes as contingent payment debt instruments, forcing you to accrue and pay tax on a “comparable yield” — phantom income — annually as ordinary income, the same trap as the zero-coupon bonds in section “Zero-Coupon Bonds and STRIPS” but with worse disclosure.
For nearly every objective a structured note claims to serve — downside-protected equity exposure, enhanced yield — you can build the position transparently from its components: a bond or T-bill for the floor and a listed option (section “Options”) for the convex piece, holding both where you can see the price and exit on an exchange. The note exists to move the spread from your account to the bank’s. Treat the entire category as something to be sold to you, not bought by you.