April begins with $183 million in structured notes sales for week; investors lean toward leverage

By Emma Trincal

New York, April 8 – For the structured products market, the first week of the month showed only $183 million in 31 structured notes deals, according to early data compiled by Prospect News.

As always, these figures are preliminary and underestimate the real tally as data from the week continues to filter in to the Securities and Exchange Commission.

The preliminary results coincided with the expanding Covid-19 pandemic that last week saw those infected topping 1 million persons globally along with the widening economic impact.

The previous week, which wrapped up March, came out with $1.662 billion of structured notes in 392 offerings, according to revised data.

The S&P 500 index closed 1.5% lower last week to 2,489, still down 26.6% from its February high, hence still in bear market territory. The same applied to the Dow Jones industrial average, down 28% from its peak.

But to confuse investors, oil prices jumped, spurring a strong two-day stock market rally, interrupted on Friday after the release of the March labor report revealing that 10 million Americans filed for unemployment in the last two weeks of March.

A bullish sign

Overall, some structured notes investors appeared more bullish, which is suggested by the type of deals pricing last week. For the first time in several weeks, leveraged deals by far outweighed autocallables, making for 70% of the total versus 15%.

This shift represented a total reversal from the year-to date trend, in which autocallables accounted for more than twice the volume of leveraged notes, or 52% versus 25%.

Easy calls

“Part of the reasons you’ve seen so many autocalls is because they sell very well,” a sellsider said.

“Autocalls tend to be sold by the big wirehouses and they pay broker commissions. You sell one. After three months it gets called. You sell another one. That’s one of the reasons their volume is so high.”

This does not happen in a vacuum. Autocalls get automatically called in a bullish environment, which was the normal trend of the market up to its peak on Feb. 19.

Short vol.

“I’m not saying they’re not good investments. They monetize volatility. But so do buffers to some degree,” he said.

“It’s true from a pricing standpoint that autocalls can monetize volatility in a more efficient way.

“You can get very high returns in the form of a coupon.”

The “monetization” is done by shorting the implied volatility of the underlying.

With a leveraged buffered note, the option position is “net short” but less premium is extracted than with the autocallable trade.

Another reason is the fact that the duration of an autocall is not fixed. The notes will have a shorter duration than the stated maturity. Probabilities indicate that autocallable notes almost invariably tend to be called on the first date 50% of the time.

“You sell the vol. on the short end of the [volatility] curve where it’s higher while leveraged buffered notes are on the long end of the curve,” he said.

This positioning on the volatility term structure reflects the anticipation that volatility will decline overtime when it just spiked.

“There’s no question autocalls price better than anything in a volatile environment,” he said.

“It doesn’t mean they’re not actively marketed by brokers because of their attractive commission structure. It gets redeemed and it rolls over.”

Fear of the unknown

Last week as mentioned was different. It remains unclear whether the “leverage” trend will continue.

Not only leveraged far exceeded the volume of autocalls but the need for protection was more pronounced: eight out of 10 of the volume in leveraged products was associated with notes including either a barrier or buffer, leaving the rest to investors unconcerned about downside risk exposure.

“I think many investors are betting on a fast recovery,” the sellsider said.

But the uncertainty around the outcome of the Covid-19 crisis remains the main focus.

“Our investors are more positioned for risk. But others are more bullish.

“Everything we see is driven by the policy responses to Covid-19. Each day the market swings one way or the other in reaction to the latest news.

“Whenever people see the light at the end of the tunnel, when they expect that the economy is going to open up soon, the market rallies.

“The unprecedented stimulus and the liquidity injections of the Fed have helped a lot.

“Many are now betting on a V-shape recovery,” he said.

But for how long?

“Everything depends on how the health crisis is going to get resolved,” he said. “And since the future of this pandemic remains totally unknown, we’re still going through some economic pain.”

More buffers, please

Among the downside protections available last week, more buffers than usual were spotted even though the cheaper barriers continued to prevail. Investors however expressed in their wish list a strong preference for buffers.

“I kind of like having a buffer. It kind of eliminates the panic feeling when you’re getting close to the barrier. It’s the principle of minimizing the maximum regret,” a market participant said.

“Also buffers tend to price better when you want to sell prior to maturity.”

Fast rally

Since the S&P 500 bottomed on March 23, the market has gained nearly 19% as of Wednesday late afternoon, encouraging investors to be more bullish. The index was already up more than 10% from Friday. While most understand that the coronavirus pandemic creates extreme uncertainty, many investors witnessing the strong rallies believe the economy will recover.

“I would encourage banks to go back to those leveraged notes using more diversified underlying including U.S. large-cap, U.S-small caps, international equity, REITs and commodities,” a buysider said.

Broken clock

Sentiment seems to ignore the bears who warn that such soaring equity prices are the signs of a bear market, which typically offer strong and short-lived rallies.

“This is not the Great Depression given how strong the economy was before the correction. It’s a health crisis,” another buysider said.

“A broken clock is right twice a day. It doesn’t matter if bears are right 2% of the time, they will tell you about the 2% they were right.”

“Bears are the only people that can be wrong 98% of the time and get away with that.”

Morgan Stanley’s $90 million

Those conflicting views leave room for leveraged notes with moderate or no downside protection, but no cap designed for the bulls as well as those providing some protection with a cap. As always, extending the maturity allows to do both.

An example of this was last week’s top deal.

Morgan Stanley Finance LLC priced $90 million of six-year leveraged notes tied to the S&P 500 index.

The payout at maturity will be par plus 150% of the index gain.

The barrier on the downside is 65% of the initial price.

Other deals

For those who prefer a hard protection, buffered digital notes offer an alternative to leveraged products.

Canadian Imperial Bank of Commerce for instance priced $24.81 million of three-year digital notes linked to the S&P 500 index.

If the index return is greater than or equal to its initial level, the payout at maturity will be par plus 26%. If the index falls by up to 17%, the payout will be par. Otherwise, investors will lose 1% for every 1% that the index declines beyond 17%. This was the second offering last week.

Finally, pure bullish plays with maximum leverage and high caps remain popular, especially for those who believe the recovery will come soon.

Credit Suisse AG, London Branch priced $17.94 million of 13-month notes linked to the Euro Stoxx 50 index.

If the index return is positive, the payout at maturity will be par plus 300% of the index return, subject to a cap of 28.5%. Investors will be exposed to the decline.

The top agent last week was Morgan Stanley with $117 million in three deals. It was followed by CIBC and Credit Suisse.

The top issuer was Morgan Stanley Finance LLC with its $90 million offering.

For the year, the top issuer is Barclays Bank plc with 538 deals totaling $3.065 billion, or 14.8% of the total.

© 2015 Prospect News.
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