UBS’ $40.51 million contingent yield autocalls on stock basket offer alternative to worst-of

By Emma Trincal

New York, Oct. 21 – UBS AG, London Branch’s $40.51 million of trigger autocallable contingent yield notes due Oct. 19, 2023 linked to an equally weighted basket of 10 stocks allow for a high coupon without having to use a worst-of, which may explain the popularity of the deal, sources noted.

The basket stocks are Apple Inc., Amazon.com, Inc., Alibaba Group Holding Ltd., Baidu, Inc., Facebook, Inc., Alphabet Inc., Netflix, Inc., Nvidia Corp., Tesla, Inc. and Twitter, Inc., according to a 424B2 filing with the Securities and Exchange Commission.

Each quarter, the notes will pay a contingent coupon at a rate of 10.5% per year if the basket closes at or above the coupon barrier, 65% of the initial level, on the observation date for that quarter.

The notes will be automatically called at par of $10 if the basket closes at or above the initial level on any quarterly observation date after six months.

If the notes are not called and the basket finishes at or above the downside threshold level, 65% of the initial level, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% basket decline below the initial level.

Unusual

It is rare to see an autocallable contingent coupon structure linked to a basket of stocks, said a market participant.

“Traditionally we see worst of two or three indices or two or three stocks,” he said.

“People would love to have autocalls on a single index, but it’s nearly impossible because your coupon gets significantly lower on a broadly diversified index. Even a single sector ETF may not be volatile enough to generate a decent coupon.”

Finding a compromise

Issuers have been trying to find solutions providing some level of diversification without dampening the volatility of the underlying.

Some investors may not want their note to be tied to a single stock due to the company risk and the volatility of the underlying, he explained. Others may be open to the exposure to several stocks without being willing to take the worst-of risk, he added.

“This deal offers an attractive compromise,” he said.

“Tech stocks are volatile enough to give you a solid return. Your basket is concentrated in well-known names many people want to have in their portfolios.

“It checks all the boxes.

“It’s an alternative to a sector ETFs. You get a high coupon and better-known names without the worst-of payout.”

Custom made

The investment theme works for investors as well.

“We live in uncertain times, but there is some comfort in tech stocks as people believe they will do well in different market environments regardless of the Elections outcome or a potential economic slowdown. There’s a belief that tech is isolated from those risks.”

Investors’ demand rather than pricing conditions may explain why those basket-linked autocalls are not seen more often, he added.

“There aren’t that many,” he said.

“It’s usually easier to do a note on an ETF or single stock than having to actively create that basket.

“If you put together the basket yourself, not everyone may agree on what should be in there. There’s a greater acceptance with an ETF than with a custom composition.”

Large deal

Overall, the deal size proved there is demand for those products.

“It’s more than $40 million. It looks like a solid deal. It’s different,” he said.

“You have a fairly deep barrier level and three years is long enough for the market to fall after the Elections with plenty of time to recover.”

An industry source also found the deal attractive.

“As a concept, I like the trade. You end up with a basket that’s highly correlated with the tech sector. If back-tested, it’s going to have a performance similar to QQQ or XLK. But you pick stocks you like, and these are by and large the biggest ones,” this source said.

The Invesco QQQ is an ETF that tracks the Nasdaq-100 index.

The acronym “XLK” is the ticker for the Technology Select Sector SPDR ETF.

Research-based

“My guess is that there’s probably some research behind the basket. That’s just pure speculation, but I wouldn’t be surprised if UBS had a research piece on these stocks saying: we believe tech stocks are driving the rally and these are the biggest ones. Something like that. It’s mostly driven by the story, the theme behind it,” he said.

He explained why he made this assumption.

“Often trading desks will be hesitant to become stock-pickers without a basis for it,” he said.

Basket-linked notes tend to be structured as leveraged return products rather than income-oriented notes, but the current context helped justify the choice of using an autocall.

“The autocall lets you take advantage of the relatively high level of volatility we currently have. It’s a straightforward way of doing that,” he said.

“From a pricing perspective you could also structure this basket with upside leverage and a cap. You would also benefit from the high level of volatility but not to the same extent as you do with this.”

Non directional

The structure is particularly adapted to this period of heightened uncertainty.

“The timing is good just a few weeks before the Elections. You don’t know what the outcome is going to be so you’re not making a bullish or bearish bet.

“The basket could outperform your note, but it could also fall. With the autocall, as long as you don’t reach the barrier you still generate the coupon,” he said.

UBS Financial Services Inc. and UBS Investment Bank are the agents.

The notes priced on Oct. 14 and settled on Oct. 19.

The Cusip number is 90281M839.

The fee is 2%.

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