Barclays’ autocallables linked to ‘FANG’ stocks offer high premium, but risks seen as high

By Emma Trincal

New York, Oct. 12 – Barclays Bank plc plans to price autocallable notes due Oct. 31, 2019 linked to the least performing of the commons stocks of Facebook, Inc., Amazon.com, Inc., Netflix, Inc. and Alphabet Inc., according to a 424B2 filing with the Securities and Exchange Commission.

The notes will pay a monthly coupon at an annualized rate of 10% to 11% if each stock closes at or above its barrier level, 60% of its initial level, on the observation date for that month.

The notes will be called at par if each stock closes above its initial level on any quarterly call valuation date.

The payout at maturity will be par unless any stock finishes below its barrier level, in which case investors will lose 1% for each 1% decline of the least-performing stock.

Roller coasters

Tom May, partner at Catley Lakeman Securities, said investors in the notes should be aware of risks associated with individual stocks.

“If you get volatile stocks like Amazon and Google, you would expect to get a big coupon. It’s not a bad investment. If you’re bullish on these stocks, it’s certainly a way to capture some good returns,” he said.

Investors familiar with the names should know how wide the trading range of some of those stocks may be, which increases the chances of breaching the barrier.

Amazon for instance has a 52-week range of $470 to $847 per share.

Gang of FANG

The volatility of those four popular momentum stocks, which have been called “FANG” for “Facebook, Amazon, Netflix and Google,” derives from a number of events and not just market movements, such as earnings, industry developments, competitors’ products and regulatory changes.

“The problem of doing these things is that single stocks have a lot more event risk than the indices,” May added.

“If you could do the same things with indices, it would be much better in my opinion. You would have the diversification advantage, and you could use a worst-of too with two or more indices. Of course, you would never have the same coupon.”

Event risk

Investing in single names could expose investors to very risky events that have a small probability of occurring but carry dire consequences for the company, he warned.

“Remember BP? No one really foresaw that,” he said.

He was referring to the Deepwater Horizon oil spill, which caused the stock of the British oil company to lose more than half of its value in the spring of 2010.

“You can’t really anticipate this type of event. Stuff happens. If it did not, you wouldn’t get the same coupon.”

The 40% contingent protection at maturity appears solid at first glance, he noted.

“It seems unlikely that any of those obviously fantastic companies would have their stock drop more than 40%, but unlikely stuff with single stocks happens. We saw that with BP in 2010, and before that we saw the same thing with the big investment banks during the 2008-09 financial crisis.”

Autocall

The worst-of structure only amplifies the risk.

“You only need one of those stocks to get wiped out. The 40% barrier looks good because you’re more likely to go through it than if you had indices.”

The notes are autocallables every quarter, a feature some investors welcome as they can get their money back with the last coupon without incurring any further market risk.

“You get some kind of risk mitigation, in theory. But if one stock tanks in the next three months, no, it doesn’t help.”

As long as investors know “what they’re getting into,” he said, the notes may provide above-average income return.

“It’s up to the investor to be aware of the risk. The stock could be flying and your coupon caps you. It could tank just the same and you would be losing some of your principal.”

Different species

The correlation between the four underlying stocks may not be as high as it appears, which brings another type of risk for a worst-of structure, said a market participant.

With worst-of products, the performance of an underlier in relation to the others is a risk factor when correlations are low or negative. On the contrary, highly correlated assets reduce the risk of breaching the barrier.

“You’d think those four stocks would be highly correlated. They’re all tech stocks. But at the end of the day they operate in very different spaces,” this market participant said.

“Amazon is a retail stock. Netflix is somewhat of a media company.

“The probability of all these four stocks being flat or positive three months from now is not high.

“On the other end, the odds are good that you’ll get the coupon with that 40% level, so that’s good.”

The coupon reflects the high volatility of each stock along with their deceptive correlations.

“The client is getting this huge coupon, which comes with risk. If one of those stocks is down 40%, you’re going to lose that much at maturity.”

He noted that Netflix, for instance, has seen its stock drop in the past as a result of disappointing shows or rises in the subscription price.

“Even Google has the ability of not being bullet-proof,” he said.

“Each one of those four stocks has different functions in the marketplace, which makes them less correlated than you would think. That’s how they can give you this coupon.”

Barrier

This market participant analyzed the barrier level, which at 60% is the same for the determination of the monthly coupon and the repayment of principal at maturity.

“For the coupon, I’m OK at these levels. For the principal, I’m concerned,” he said.

“You could be collecting the 10% for three years ... best-case scenario ... but then one stock is down 40% at maturity. You’d be down 10%, and at the end of the day you would have earned nothing.”

Unlikely call

The autocallable feature could reduce the risk of principal loss and eliminate it if it occurred. But the odds of the notes being automatically called are small, according to this market participant.

“Even in a flat market, you’re probably not going to get called that easily. One of the stocks will be down when the three others are up,” he said, commenting on the trading session on Wednesday.

Amazon, Facebook and Alphabet closed a few points higher on Wednesday compared to the previous day, but Netflix dropped $1.09 from Tuesday’s close.

“That’s in a flat market. What are the odds that on a specific day three or six months from now none of those stocks would be down from where it’s at today?

“But then again that’s why you do a worst-of. It cheapens the options, and it allows you to get a much better coupon and a deeper barrier.”

Barclays is the agent.

The notes (Cusip: 06741VCB6) will price Oct. 26 and settle on Oct. 31.

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