Barclays’ capped gears linked to Financial Select Sector target moderately bullish investors

By Emma Trincal

New York, April 23 – Barclays Bank plc’s 0% capped gears due June 30, 2020 linked to the Financial Select Sector SPDR fund are designed for investors seeking to leverage up moderate growth in the financial sector, sources said. But the absence of any downside protection was a concern.

The payout at maturity will be par of $10 plus triple any fund gain, up to a maximum return of 15.35% to 16.35%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be fully exposed to any fund decline.

Flattish outlook

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, noted that it did not take much increase in the fund to take investors to the maximum return.

“You’re talking about a note that rewards a flat, slightly up market. But if it’s down or if it goes up a lot, you are penalized. There is no downside protection, and you have a cap.

“The only way you get rewarded is if the index doesn’t go up that much.”

The “reward” in this scenario would be to receive the maximum return. Using a 15.85% cap, set at the midpoint of the range, this would be 13.45% on an annualized compounded basis. Such outcome would be easy to achieve: the ETF would only have to rise by 4.5% a year.

Banks in pain

“I don’t find this note very appealing, but part of it is my view on the sector,” said Chisholm, who was concerned about the lack of downside protection in the structure.

“I don’t see any reason to focus on financials right now. It’s the least attractive sector.”

The recent inversion of the yield curve (between the 10-year and three-month Treasuries) revived fears of an impending recession.

Since then the spread has become positive again but remains close to flat at 13 basis points.

Between the two-year and the 10-year Treasuries, the spread is only 21 bps. It was at 50 bps a year ago.

Underperformance

“The curve is still very flat. I don’t see the two minus 10-year spread widening in the banks’ favor,” he said.

“The top 40% of the ETF portfolio are big banks,” he observed.

“We’re on our way to an inverted yield curve. Banks won’t make any money for lending.

“So I don’t think this is the best sector play out there.”

Earlier this month, big U.S. banks reported positive first-quarter earnings. The Financial Select Sector SPDR fund is up 15% year to date.

But Chisholm remained pessimistic about the sector’s outlook.

“It’s underperforming the S&P 500,” he said, pointing to the 17% rise in the S&P 500 index this year.

“The curve is still flat and is likely to be inverted. Historically, we know that inverted yield curves have been a reliable signal of recessions.

“If the banks are not able to lend at a positive spread, it will hurt their bottom line.”

The structure did not help. Lacking downside protection while having limited upside was a major drawback for this adviser.

“If the market is down, you have no protection. If it takes off, you’re capped.

“I’m not sure why I would invest in this.”

Options game

Jonathan Tiemann, president of Tiemann Investment Advisors, said the absence of any buffer or barrier made the structure “easy to replicate” with options.

“You own the ETF and you buy three at-the-money calls. That’s your 3x upside exposure,” he said.

A call is “at-the-money” when the underlying price is at the same level as the strike. In this case, the calls are “at-the-money” because the strike price and the initial price are the same.

“For the cap, you sell three out-of-the-money calls.”

Selling a call is betting that the underlying will not exceed a given strike. In this case, the strike is at the level of the cap. If the underlying price moves above it, the seller of the calls has to sell the underlying at the strike price, which is similar to “capping out.”

Since the initial price is lower than the cap and not higher, the embedded short call is said to be “out-of-the-money.”

Bespoke deal, maybe

Beyond the fact that the structure was simple enough to be easily replicated, Tiemann was wondering how the product would fit in a portfolio.

“It’s a peculiar view to think that the ETF will go up but only by a little bit. Meanwhile, you’re not worried about protecting the downside,” he said.

“It doesn’t hedge any exposure you might have in the portfolio.

“I suppose it’s not uncommon for issuers to custom-make a product for a very particular need. This is probably the case here.

“I just can’t figure out what that need would be.”

UBS Financial Services Inc. and Barclays are the agents.

The notes will price on Thursday.

The Cusip number is 06747A490.

© 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.