GS Finance’s leveraged buffered notes tied to S&P 500 offer short-term defensive play

By Emma Trincal

New York, May 1 – GS Finance Corp.’s 0% leveraged buffered notes due Nov. 18, 2020 linked to the S&P 500 index are designed for investors seeking short-term exposure to U.S. stocks with less risk than buying the index outright, sources said.

If the index return is positive, the payout at maturity will be par plus 2 times the index return subject to a maximum return of 13.2%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 15% or less and will lose 1% for every 1% that the index declines beyond 15%.

Cautious exposure

Jonathan Tiemann, president of Tiemann Investment Advisors, pointed to the risk-averse nature of a potential investor in the product.

“You can’t be too bullish with this note because your upside is limited by the cap. The leverage helps capture some return,” he said.

“This is for cautious investors who need to be in the market. But they also need the protection.

“They want the exposure but they’re skittish. They’re not too worried about underperforming if the market goes to the moon.

“At least, this view makes sense. It’s a conservative bet... It’s not unreasonable.”

The 18-month note with 2x leverage provides a maximum return of 13%, which is about 8.5% a year on a compounded basis.

“You will underperform if it goes up a lot. But the note is not designed to outperform. It’s designed to reduce your risk,” he said.

Collar

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said that while the upside was capped, at least the 15% buffer over the 18-month period offered some value for conservative investors.

“You’re buying the S&P over 18 months and you’re putting a collar on it,” he said.

A collar is an option trade, which consists of buying a put and selling a call at the same time. Most structured notes replicate this strategy when the structure features a buffer on the downside and a cap on the upside, which are the equivalent of being long a put and short a call, respectively.

“You eliminate some of your possible gains on the upside but you also eliminate some of the downside risk,” he said.

“It’s a pretty standard trade. It’s within reason.”

Directional bet

The notes would appeal to moderately bullish investors. It would only require a 4.3% annual increase in the index to bring investors to the maximum return level.

“You sometimes see notes with limited upside and no buffer. Those are useless. With this one I can see how it would make sense,” he said.

“The market is flat. You’re doing OK.

“It’s moderately down or even down. You outperform the market.

“It’s only if the market rallies above the cap that you will underperform.

“So in a way you’re making a directional bet.”

It is a bet on the direction of the market and also on volatility since a strong uptrend would cause investors to underperform.

“You’re just not aggressively bullish,” he said.

Not really a hedge

The 15% buffer on an 18-month period was attractive even though it was a tradeoff.

“It’s costing you your upside. 13% in one-and-a-half years isn’t much,” he said.

Buffers at times are used by structured notes investors as a way to hedge a long position in a portfolio.

Chisholm did not think it was a sound strategy in this case.

“There are cheaper ways to provide a hedge without giving up so much on the upside,” he said.

“Volatility is very low right now. It’s cheap to buy insurance with options.

“This is not a hedge. If you want to hedge you can choose different strategies.”

The notes will be guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the underwriter.

The notes will price on May 13.

The Cusip number is 40056FCB9.

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