After Facebook, Twitter tumble, timing for autocalls looks right, but buyers lack conviction

By Emma Trincal

New York, July 27 – When tech stocks tumble as Facebook, Inc. and Twitter, Inc. just did, the “buy-on-the-dip” mantra may lead firms to price short-volatility structures on the decliners. In doing so, issuers can extract more premium to raise the coupons and price deeper barriers for autocallable notes. After all, income-seeking investors are always on the lookout for bargains.

But this scenario in reality may be different.

On Thursday, the share price of Facebook dropped 19% after the company released disappointing earnings the night before, revealing slower growth ahead. The more than 41-point plunge for Facebook marked the worst one-day market capitalization loss ever. The stock closed on Thursday at $176.00.

The next day, Twitter followed suit shedding 20.5%.

“We’ve been showing today some levels on both Facebook and Twitter. Both stocks fell as a result of their earnings. We’re looking into it. But no one has pulled the trigger yet,” a sellsider said.

Is it fear that a technology correction is already unfolding or is it that pricing does not yet match investors’ return expectations given the perceived risk?

“A little bit of both,” said this sellsider.

The market reacts swiftly to earnings announcements. But when to strike a deal remains difficult to time.

“Volatility goes up just before the earnings. After the announcement, when uncertainty has been removed, it’s not unusual to see implied volatility going down even though the stock drops,” he said.

A series of deals

This could explain why some deals, which priced after the slump on July 26, did not always exhibit significantly better rates than recent prior ones.

UBS AG, London Branch provides interesting comparisons as this issuer priced a number of two-year trigger phoenix autocallable optimization securities on Facebook before and after the earnings.

All those deals displayed the same maturity date, autocallable contingent coupon structure, European barrier, quarterly payments and call dates. The 1.5% fee was the same. The only variables were the coupon amount and the barrier level.

UBS priced $877,500 of two-year trigger phoenix autocallable optimization securities linked to Facebook on July 26 at the discount price of $176.26 a share. The contingent coupon is 12.52% based on a trigger price of 80%. The notes will be automatically called if the price is above its initial level. The barrier at maturity is 80% of initial price.

UBS priced the same deal on the same day for $200,000. The coupon was 11.76%.

In those examples, the double-digit contingent coupon is consistent with what one would expect after the stock tumbled on that day.

Another example though does not follow the same logic. On July 26 as well, UBS priced the same deal for $350,000 with a 7.77% contingent coupon. The difference in coupon sizes is striking for same-day pricing even if the last offering showed a slightly different barrier: 75% instead of 80%.

And yet, another deal with a 75% barrier priced for $100,000 on July 13. At the time, the initial share price was $207.00. The 8.58% coupon was nevertheless higher than the previously mentioned deal.

Volatility and price

For the sellsider, these inconsistencies are based on volatility levels.

“Earnings drive prices based on surprise. When the surprise disappears, volatility will usually fall as a result. So, you can’t just look at how much the price fell on that day,” he said.

Pricing is also not always rational. Investors so far had a strong appetite for the FANG trade. But behaviors change when prices fall so strongly.

The acronym “FANG” stands for Facebook, Apple, Netflix and Alphabet, which is Google’s parent,

“Typically, when retail investors see news, they don’t jump immediately on the stock,” the sellsider said.

“People want to know what’s going to happen with Facebook or Twitter. I haven’t seen anyone with a strong conviction yet.

“Everyone is looking at it...see if someone is going to do something.”

What lies ahead

Investors’ interest will be key, especially as the technology sector is weakening.

The Nasdaq fell 1.5% on Friday. But Facebook’s bleeding eased with the share price down 1.78% for the day.

If Twitter and Facebook were punished by shareholders, Alphabet hit new record highs after reporting strong profits, yet finished the session lower.

With a number of popular Nasdaq stocks severely hit, some are wondering if it is a good time to buy “low” or if on the contrary these sharp declines may be the sign of a tech bubble about to burst.

Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments, is among those who believe it is the latter.

“Stocks like Facebook that have been extremely popular will be the most vulnerable if we’re entering into a bear market, which I think is already happening,” said Kaplan.

“It’s the stocks with a high P/E ratio that get hurt the most.”

“These kinds of moves, 20% down on one day, are often signs that we’re transitioning into a bear market.

“A decade after the 2008 crash people forget. They forget emotionally what it’s like to be in a bear market.”

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