Goldman Sachs' trigger notes linked to S&P 500 offer attractive short-term market exposure

By Emma Trincal

New York, Feb. 13 - Goldman Sachs Group, Inc.'s 0% index-linked trigger notes due March 4, 2015 tied to the S&P 500 index offer a good alternative to a direct market exposure for short-term investors cautious about a pullback, sources said.

If the index closes at or above the 81.5% trigger level on every trading day during the life of the notes, the payout at maturity will be par plus the greater of 0% and the index return, up to a 15% cap, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, the payout will be par plus the index return, with full exposure to any losses and any gains capped at 15%.

Getting this protection with a decent cap on a short period of time is partly made possible by the recent volatility pickup, a market participant said.

Additionally, the use of a barrier that can be triggered any day (American barrier) versus the more common final-day barrier (European option) is also a factor.

"This is a play to get exposure to the market taking advantage of the recent spike in volatility," this market participant said.

Volatility factor

"With the recent volatility pickup, they've been able to build in a 18.5% barrier for the S&P, which is pretty good. Even with the observation on a daily basis, it's still pretty attractive," he said.

The structure offers a "fair" payoff, he noted, in that investors have to "give up some of the upside" but at a limited cost.

Upside

"On the upside, I would have liked to see a little bit of leverage, but the 15% cap is fairly decent," he said.

"Are we going to be up by more than 15% in the next year? Probably not. The cap doesn't limit your upside too much.

"You're not giving up too much on the upside because getting more than 15% in a year is possible but not likely. You're giving up the dividends, but it's only for one year."

In exchange, he noted, investors benefit from the 18.5% contingent protection on the downside.

Helpful protection

"The barrier really helps," he said, but only in the absence of a major correction.

"If you see the market not doing too well, down 5%, 10% without breaching the barrier, then your principal is protected. It could be useful.

"If nothing else, psychologically speaking, it's helpful for people who want to continue having market exposure.

"What you're giving up is not that much, but you're getting a protection which may possibly work to your advantage."

The notes are aimed at the cautiously bullish investor, he said.

"It's for someone who wants exposure to the S&P but who is cautious," he said.

"Given that it's only one year, you're not taking on that much risk. You're not getting that much reward, to be honest. But it's a decent alternative to the index."

Daily observation

John Farrall, director of derivatives strategies at PNC Wealth Management, said that the barrier is not such a high price to pay in order to get the 18.5% contingent protection as long as investors do not expect a major correction and understand the way the feature works.

"People are going to have negative reactions with a barrier that can be breached any trading day. But if it's a low-probability event - I haven't done the math, but I bet it is - I don't think it's such a big deal as long as people understand that it's a barrier, not a buffer," Farrall said.

"The only penalty you're incurring is that the downside protection goes away. But your upside stays the same, capped at 15%. So whether you get a rebound or get a negative return, it's only the fact that the barrier no longer exists that makes the difference."

Modest pullback

Many investors see the S&P 500 finishing up the year in positive territory, but very few expect the benchmark to post returns as high as last year, when it closed up 32%. On the other hand, the expectation of a market downturn is widespread. While the notes would not be suitable for bearish investors, they may offer a conservative way to be long the market, he explained.

"If you're not anticipating a major correction, but just a 5% to 10% pullback, which we haven't seen in the last 500 or so trading days, you're getting a good protection," he said.

"I kind of like it.

"I see it as very suitable for someone who wants equity exposure but doesn't expect the market to hit new record highs. At the same time, if they see a pullback, they don't expect much more than a 10% or 15% sell-off.

"It's quite a nice structure."

The final level of the index will be the average of the closing levels on the averaging dates, which are expected to be the five trading days ending Feb. 27, 2015.

Goldman Sachs & Co. is the underwriter.

The notes will price on Friday and settle on Feb. 20.

The Cusip number is 38147QNX0.

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