UBS’ $700,000 phoenix autocalls on Ford pay high rate, but barrier risk is real, analyst says

By Emma Trincal

New York, Jan. 29 – UBS AG, London Branch’s $700,000 of trigger phoenix autocallable optimization securities due Feb. 1, 2023 linked to the common stock of Ford Motor Co. offer a high coupon, but the chances of losing money at maturity are relatively high given the volatility of the underlying stock, said Suzi Hampson, head of research at Future Value Consultants.

If Ford Motor’s stock closes at or above the trigger price – 70% of the initial share price – on a quarterly observation date, the issuer will pay a contingent coupon for that quarter at the rate of 24.54%, according to a 424B2 filing with the Securities and Exchange Commission.

If the shares close at or above the initial price on a quarterly observation date, the notes will be called at par plus the contingent coupon.

If the notes are not called and Ford Motor’s shares finish at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

Volatility up

“You wouldn’t think about Ford as a high volatility stock at first. Yet its implied volatility is 50%,” said Hampson.

She pointed to the “volatility of the volatility,” of the stock.

“Looking at last year’s implied volatility we see significant moves. In March it dropped to the low 30’s. In the last three months it jumped somewhere in the 40’s. In the beginning of January, it was in the low 40s. Now it’s in the low 50s.”

Such volatility moves present an opportunity for structured notes investors.

“For income-paying products having an underlying showing a recent spike in volatility will give you a higher coupon. The expectation is that hopefully it will come down to its resting level. You can strike with a high coupon and the risk is less. It’s ideal for investors,” she said.

Five scenarios

Future Value Consultants offers stress-testing on structured notes encompassing simulation tables as well as back-testing analysis.

Five distribution assumption sets are included in the firm’s report. They represent five market scenarios, which are based on volatility as well as different growth rate assumptions. Those are bull, bear, less volatile and more volatile. In addition, a neutral scenario is the basis of the simulation in all reports. It reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying.

The growth rate in the neutral scenario is 0.19% for this product, based on a research report Hampson generated for the notes.

“That’s because the dividend is 0%. The neutral growth is barely anything,” she said.

The bullish growth assumption is 7.19%.

“Because the volatility is so high, we used our model’s top growth rate of 7% to which we add the 0.19% neutral rate.”

Hampson analyzed the probabilities of return outcomes. She conducted her analysis using the “product specific tests,” one of the 29 tests or tables included in each report.

The main outcomes with this structure are barrier breach, calls at various dates and coupon payments at various times.

Barrier outcomes

The barrier breach outcome has a probability of 22.49%, according to the table.

“It doesn’t seem to be too bad,” she said.

“We’ve got quite a few call points. It’s going to help.”

She added the probabilities of calls for the seven quarterly determination dates, leading to a 72.2% chance of a call on any of those dates in the neutral scenario.

“Obviously, if you have a 72% chance of calling, that lowers the risk. If you call you get your money back,” she said.

She compared the probabilities associated with the non-occurrence of a call and the breaching of the barrier at 27.8% and 22.49%, respectively, in the neutral scenario.

“These are very similar,” she noted.

The 5.31% difference between the two probabilities represents the “not so likely” scenario in which the underlying finishes negative but above the barrier level.

“That’s when the barrier works for you. As you can tell, it isn’t actually doing much,” she said.

She explained why:

“If you get to the end... at these levels of volatility, you’re more likely to breach the barrier because it means you have been below 100 seven times in two years. If you haven’t kicked out, you’re already down quite a bit.”

The value of the barrier depends on the barrier level and volatility.

“You could have a similar distribution of probabilities with an index underlying and a 90% barrier for example. The barrier would be less defensive, but the volatility would be lower.”

Calling soon

The probability of a call at point one is 46.21% in the neutral scenario and 49.04% in the bull scenario, according to the test.

“It’s below 50%. If you increase the growth rate, that probability will go up.”

Naturally, the chances drop in the bear scenario, which displayed a 43.56% probability of a call occurring at point one.

The chances of a call diminish rapidly after the first call point, which is typical for this kind of product, she said.

The odds of a call at point two are only 11.47% and drop to 5.81% at point three. There is only a 1.04% chance of a call on the last observation date, at point seven.

“The first call is in line with autocallable probabilities in general. It doesn’t really rely on the volatility of the underlying. But it’s in the later autocalls that you start to see some of the impact of volatility.

“With an autocall, all you want is the underlying to be up or flat. We’re not interested in the magnitude.”

Coupon payments

A look at the probabilities and frequencies of collecting one coupon payment only showed that there is a difference between receiving payment upon the call at point one (probability of 46.21%) and receiving one payment overall (probability of 53.06%).

The difference between the two outcomes – a 6.85% probability – is not significant, she said. But it illustrates how rare it is to get paid only once without seeing the notes called on the first call date.

Setting expectations

Investors in autocalls usually know, and if not, need to keep in mind that there is a difference between the maturity of an autocall and its duration, said Hampson.

“The highest probability of a single event is call at point one, I get my coupon. That’s the important thing to consider. It happens half of the time,” she said.

“If you get into this trade with the expectation of collecting a coupon for two years, you shouldn’t really be investing in that type of product.

“You don’t want to hold it until it matures. If you’re in it for two years, you’re probably going to lose some capital.

“What you want is the positive outcome: getting a call at the end of the first quarter or within the first year.”

The table showed a 66% probability of a call within the first year.

“You want to be in that 66% bucket and walk away with your principal and coupon because if you don’t the chances of breaching the barrier are quite high.

“This is not a two-year fixed-income product,” she said.

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes priced on Jan. 27 and settled on Friday.

The Cusip number is 90284U135.

The fee is 1.5%.

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