HSBC’s dual directional trigger PLUS tied to Facebook requires tolerance for risk, bullishness

By Emma Trincal

New York, Aug. 17 – HSBC USA Inc.’s 0% dual directional trigger Performance Leveraged Upside Securities due March 3, 2021 linked to Facebook Inc. stock is a risky proposal given the volatility of the underlying stock, said Almudena Rojas, structured products analyst at Future Value Consultants. But for bulls who like the stock, the notes deserve a closer look.

If the stock finishes above its initial level, the payout at maturity will be par plus 150% of the gain up to a maximum return of 38%, according to a 424B2 filed with the Securities and Exchange Commission.

If the stock falls by up to its 80% trigger level, the payout will be par plus the absolute value of the return.

Otherwise, investors will be fully exposed to any losses.

Recent plunge

“It’s quite an interesting product given the volatility of the underlying stock,” Rojas said.

The majority of leveraged notes tend to be based on equity indexes, less often on a single stock as it is the case with these notes, she added.

And Facebook, one of the so called “FANG” stocks (for “Facebook, Amazon, Netflix and Alphabet’s parent Google) has gone through wild moves this year.

From a low when the company’s chief executive at the end of March testified in front of Congress amid a privacy scandal to a peak four months later, the share price jumped 45%. But on July 25, it plunged 19% to $176 a share. Trading close to $174 in mid-afternoon session on Friday, the price has not yet recovered from last month’s crash induced by disappointing earnings.

Trap or bargain

“This note features various elements that make it very risky and suitable to only a certain type of investor as it requires a specific risk tolerance profile,” Rojas said.

“Historically Facebook has been a high-performing stock. But it dropped significantly last month and remains lower as the current market volatility isn’t helping,” she said.

“It’s up to investors to decide whether they feel comfortable to invest in a stock with an 80% barrier, a level that has been breached less than a month ago in just one day. Some may feel that it is a bargain at current levels. It’s a personal decision.

“But anyone seriously considering investing in this product should be bullish and also have a fair knowledge of the stock.”

Stress testing

Future Value Consultants offers stress testing reports on structured products containing a Monte Carlo simulation as well as back testing analysis.

Each report comprises 29 tables or tests, which can be customized in any combination.

The simulation is organized around a neutral scenario and four market assumptions – bull, bear, less volatile and more volatile. For any tested product, the model generates the growth rate and implied volatility of the underlying.

Those hypothetical figures vary according to the market conditions. But the methodology is overall conservative. Even for the bull and the bear scenarios, the hypothetical growth rates are muted by design.

For bulls

For instance, the bullish scenario for this product showed an increase in the stock of 9.8% over the two-and-a-half year period, which is different from what one would expect of a bull market, she explained.

The neutral scenario has even less relevance as it is based on the risk-free rate, which would not be suitable as a basis to test a bullish equity product like this one, she explained.

However, comparing the bullish scenario with the other market assumptions can be helpful for the understanding of the product, she added.

Probabilities of outcomes

Examining the report for these notes, she picked one of the tables called “capital performance tests.” It provides information market by market on probabilities of outcomes and average payoff.

This structure can only bring three outcomes: return more than capital; return exactly capital; and return less than capital, which represent three rows on the table.

The notes generate either a gain or a loss. Therefore, the probability for “return exactly capital” (par only) is zero, she said.

“If we stick to the bull scenario, we have a 79.9% chance of getting more than capital, which is high,” she said commenting on the table.

“This result takes into account not just the upside up to the cap but also the first 20% decline in the stock, which gives you the absolute return.”

On the other hand, investors will lose capital approximately 20% of the time.

“These probabilities are very encouraging if you’re bullish,” she said.

Divergences by markets

Looking at the other market scenarios, she pointed to notable dispersions of probabilities.

For instance, the bearish assumption showed a probability of gains of only 52%.

“In terms of probabilities, it makes a big difference whether you pick the bull or the bear scenario,” she said.

Payoff

One may wonder why the chances of a positive versus negative return would be 50/50 in a bear market.

“This is the advantage of the dual directional structure. As long as you don’t breach the barrier, you can make money on the downside too,” she said.

On the other hand, average payoff distributions show less disparity, according to the same table.

In the bull scenario, investors will get an average payoff of 127.3% at maturity. The bear market in comparison showed a lower average. But it is still 121.8%.

“The difference in payoff isn’t dramatic but in the case of the bull market it will happen 80% of the time while in the bear scenario, it’s only going to be half of the time,” she said.

“You’re more likely to be paid in the bull scenario.

“You’re getting a relatively high average payoff in the bear market and that’s only because you benefit from the absolute return,” she said.

“Here is a very risky product tied to a volatile stock. The stock shows a high likelihood to finish below its initial price. The silver lining is that the product also provides some relief and positive return on the downside.”

Milder risk

Despite the absolute return feature, investors in the notes should have a strong bullish conviction,” she said.

“They should also know the stock and be willing to take on some significant risk.”

Investors need to assess their risk tolerance in order to determine whether they may be better off without the absolute return feature, she said.

“The dual directional feature is quite expensive because you get paid on the downside,” she added.

“You get the protection plus the return.

“Some investors may prefer having a buffer instead because for a stock like Facebook, an 80% barrier isn’t all that much as we’ve seen just recently.”

HSBC Securities (USA) Inc. is the agent.

The notes will price on Aug. 31.

The Cusip number is 40435X587.

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