HSBC’s $6.31 million barrier digital notes tied to Amazon, Facebook offer mildly bullish bet

By Emma Trincal

New York, Dec. 13 – HSBC USA Inc.’s $6.31 million of 0% barrier digital return notes due Dec. 16, 2019 linked to the lesser performing of the common stocks of Amazon.com, Inc. and Facebook, Inc. offer a good risk-adjusted return for mildly bullish investors in the two popular stocks, said Tom Balcom, founder of 1650 Wealth Management.

If each stock finishes at or above its barrier price, 60% of its initial share price, the payout will be par plus 31.75%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will be fully exposed to the decline of the lesser-performing stock.

Digital

“You’re getting 9.62% a year compounded as long as the stocks don’t drop more than 40% three years from now. That’s about 10% a year ... Nothing to sneeze at,” he said.

The notes should not be shown to fixed-income investors given the high risk.

“It’s very appealing for yield-starved investors. But it’s not designed for fixed-income clients, who are conservative by nature. The two underlying stocks are too risky.”

For mildly bullish investors with existing positions in these two stocks in their portfolio, the notes may be attractive, however.

Exit strategy

“If you want to lock in your profit while keeping the exposure, this might be a way to generate an extra 10% a year even if there’s a pullback,” he said.

“Those two stocks may be very volatile, but I don’t know what would cause any of them to fall by more than 40% point to point.

“Most people are confident with those names. There will always be great demand for those products.

“Forty percent is a pretty hefty barrier. Even if Amazon is down 20%, you’re up 32%, you outperform by more than 50%. I think it’s the client who’s going to send a gift to the adviser at Christmas, not the other way around.”

Not for bulls

While confident in the downside protection except for risk-averse portfolios, Balcom said the notes still limit the upside. Therefore, the trade would not be appealing to very bullish investors.

“It’s only for someone who thinks there is room for a little bit more upside or alternatively people who believe there might be a pullback but are not really bearish. If you think this thing can double in three years, obviously you wouldn’t buy this,” he said.

The share price of Amazon did actually double in the past three years. Facebook has gained 125% during the same time.

Barrier

Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments, was more cautious about the risk-adjusted return of the product.

“I can perfectly see Amazon breaching the barrier. It has happened before,” he said.

In November 2008, the stock fell by nearly half from its August 2008 level. During the 2000-2001 bear market, the share price plunged 95%.

“If we have another bear market, of course it could drop more than 40%. The benchmarks have dropped that much during bear markets, and these are widely volatile stocks,” he said.

He noted that during the 2000-2002 bear market, the S&P 500 and the Nasdaq lost 45% and 60%, respectively.

Kaplan said that both stocks are richly valued.

“I would much rather recreate the position myself by selling puts on those two stocks. But I would certainly not do that right now.

“Warren Buffet set the example. He would sell the puts after a recent drop when the premium was temporarily inflated.”

Timing

In using the notes, investors are somehow “replicating” a put sale trade, only they are “selling at random” at a time when volatility is not high enough to pay a rewarding premium given the risk taken. His preference would be to wait for a decline and sell the puts.

“Then if it goes sideways or rises again you can close the position and buy back the put at a lower price,” he said.

Another issue is the downside protection.

“While you have some room on the downside, once one of the two stocks drops more than 40%, you don’t have any protection. In fact, you are guaranteed to lose at least 40%. With the put, you have a much better protection.”

HSBC Securities (USA) Inc. was the agent.

The notes (Cusip: 40433UXH4) priced on Dec. 9.

The fee was 1.75%.

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