HSBC’s $425,000 buffered digital notes on ETFs offer mildly bullish bets on oil, financials

By Emma Trincal

New York, Oct. 7 – HSBC USA Inc.’s $425,000 of 0% buffered digital notes due Oct. 5, 2023 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund and the Financial Select Sector SPDR fund offer attractive terms, but investors should consider the volatility of each underlying as well as their correlation, sources said.

If the final share price of the worst-performing fund is greater than or equal to 80% of its initial level, the payout at maturity will be par plus 38%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will lose 1% for every 1% that the worst-performing ETF declines beyond 20%.

Oil and gas

“It’s looks OK,” a market participant said.

“The digital return is good and the 20% buffer, pretty attractive.

“But financials and energy are the weakest performing sectors this year. So, investors should keep this in mind.”

This market participant said that he was relatively bullish on financials but not on energy.

He was particularly skeptical about the oil and gas exploration segment of the energy sector.

“I’m not sure what pipeline development will look like with cheap oil. These exploration companies have more leverage on their books. They’re more volatile than the overall energy industry,” he said.

The oil and gas exploration and production ETF comprises companies that are involved in exploration and production of crude oil and natural gas as well as refining and transportation. The fund’s top constituents are Chevron Corp., Devon Energy Corp., Parsley Energy Inc., ConocoPhillips and Occidental Petroleum Corp.

Lagging performance

The ETF share price is down more than 55% since its 52-week high of mid-January.

The financial ETF on the other hand lost 21% from its February high.

The funds offer distinct risk profiles with the SPDR S&P Oil & Gas Exploration & Production ETF much more volatile than the other fund. Implied volatility for the energy fund is 57% versus 32% for the financials ETF.

“The risk is definitely in the energy fund,” the market participant said.

“If I were to play this weak sector, I’d rather do a growth note in an uncapped fashion so I could outperform both on the upside and on the downside, the market participant said.

“Alternatively, if I was inclined to get some income, I would look for an autocall instead of a digital. No buffer... but a deep coupon barrier so I could still get a decent yield. You can do that with the worst-of, especially with one of the funds being so volatile.”

Other ways to play

The low valuation and high volatility of the energy ETF almost commended the use of a different product, according to this market participant.

“It’s an attractive note, don’t get me wrong. It’s a good story too, and digitals are great structures, easy to explain and to understand.

“But I think there are other ways to play a sluggish sector like energy.

“This is a bullet structure, so there is no income. To not have a call on a structure like that to me is missing a yield opportunity. And if it has to be a bullet, I might prefer a straight growth product with no cap.

“In any event I think energy prices are low for a reason. There are plenty of risks in the sector. Investors should make sure they are compensated for such risk and get the downside protection level they’re comfortable with.

“I tend to prefer autocalls as a mean to mitigate risk when the underlying is very volatile as it is the case for one of them here.”

ETFs bets on the rise

An industry source said he has seen an increasing number of investors using ETFs to express views on certain sectors.

“Most of the time it’s done with autocalls. This one is a digital. But the idea is the same. People tend to use a couple of ETFs in a worst-of in order to increase the return.

“If they have a low correlation, it prices better. That’s how you can generate higher yields,” the source said.

The three-year coefficient of correlation between the two ETFs is relatively low at 0.67.

Whether the structure pays a digital return at maturity, a coupon or a call premium, investors do not have a strong directional view, this source noted.

“The rationale here is that you’re only mildly bullish or mildly bearish about the oil exploration industry,” the source said.

The same applied to the Financial Select Sector fund.

“If you’re very bullish or bearish you shouldn’t buy this.

“To use a worst-of is to maximize your yield. You’re not looking for appreciation. Here it’s a digital coupon. Either you get the digital coupon at maturity or you don’t.

“If you’re comfortable with both sectors, the idea is pretty simple: you take some downside risk and limit your upside for a fixed return,” the source said.

HSBC Securities (USA) Inc. is the underwriter.

The notes settled on Oct. 5.

The Cusip number is 40438CWZ0.

The fee is 0.4%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.