Action slows with $257 million of structured products issuance; investors show indecisiveness

By Emma Trincal

New York, Aug. 24 – Structured products issuance volume was light last week as traders are off on vacation while the market is not moving in any clear direction.

Firms priced $257 million in 113 deals, a 31% decrease from the previous week, according to data compiled by Prospect News.

Asked if he was busy, a trader responded: “I wish I was.”

The equivalent week in July in the monthly cycle – the third – saw more action with $453 million in 136 offerings.

Last week saw much smaller deals than usual, with the top one at less than $20 million, the data showed.

The S&P 500 index was nearly unchanged.

A sellsider pointed to some factors.

Fear of August

“You have extremely low volatility, so in general, pricing doesn’t look good. The market is range bound, near all-time highs,” he said.

“We’re also approaching September, which is not a great month for stocks. As a result, people are staying away from the market.

“All of these things are affecting investors’ behavior right now.”

So far volume this month through the 19th is flat compared to the same period in August last year, which included the China stock market rout.

But people have a memory and last summer’s fears are still visible, according to Paul Weisbruch, vice-president of options sales and trading at Street One Financial.

“Last August was an out wire that precipitated a global sell-off. Going into August this year there were questions and some fear: Oh it is August again. Look at what happened last year!” he said.

The reality is different, he noted, with stock prices barely moving.

“We’re in slow grind, volatility is very low and we’re in very tight trading ranges,” he said.

“The VIX is between 11 and 12. It was at 26 at the end of June. That was the U.K vote. But the Brexit was digested and swallowed.”

Calm market

After hitting all-time highs at 2,194 earlier in the month, the S&P 500 has been trading in a range. The benchmark was at 2,180 in mid-afternoon session on Wednesday.

“We haven’t seen huge upside days. The S&P is not even at 2,200 yet. There is no urgency to get in the market at these levels, Weisbruch said.

“At the same time investors continue to be superstitious in a way. After August, people will worry about September and October will be worse.”

The stillness in stock prices does not help issuers and sellers of structured products.

“People who rely on volatility trading are at a disadvantage. When volatility goes lower, anyone who owns options suffers and anyone who is long volatility suffers too,” he said.

September FOMC

Another factor keeping investors in structured notes linked to equity is the direction of interest rates for the remainder of the year. All eyes are on the September Federal Open Market Committee meeting, he said.

“Are they going to raise rates? Everybody is trying to guess the next move. We know that if they don’t hike in September, the next decision will be in December. That leaves some room for a nice rally in the fall and that’s also why people are sitting on the sidelines right now. It’s a wait-and-see situation,” said Weisbruch.

Hunt for yields

Low yields across all markets but also uncertainty about how much longer the bull market can last continue to drive flows into income products that generate competitive coupons, said the sellsider.

Autocallable reverse convertibles accounted for 45% of last week’s total compared to 22% for the year-to-date average, the data showed.

“If you’re looking to put your money to work, a structure that can give you six, eight or 10% based on the market not going down below a certain level, if you’re not so much concerned about the performance as we’re seven years and counting in a bull market, I think that’s more attractive to people,” this sellsider said.

“What’s the impetus to drive another 10% in the market?

“If you can capture equity-like returns knowing what you risk, I think that’s a smart bet.”

Contingent income deals let investors earn a coupon when the underlying is above a coupon barrier at a set date. The downside is also limited by a barrier. While there is no upside participation (the coupon is a cap), investors know in advance in which conditions they may lose principal.

“People continue to reach for yield in riskier asset classes such as these notes or emerging markets and high-yield bonds,” said Weisbruch.

“Equities are at their high and yields are low everywhere.

“It means risk-on trade. People embrace risk.”

Top offerings

The top deal last week was based on a low-volatility strategy with the issuer using two of its proprietary indexes.

Deutsche Bank AG, London Branch priced $18.32 million of two-year tracker notes linked to a basket that included the S&P 500 Total Return index, the Deutsche Bank Equity Risk Premia 5% VT Portfolio – USD – Excess Return index and the Deutsche Bank ProVol Hedge index. Both indexes are algorithms with volatility targets.

The notes were linked to the basket return. Investors were exposed to one times the return of the S&P. But for the Portfolio index and the ProVol Hedge index, the exposure was 1.8 times and 2.2 times any increase or decrease in the level of each index, respectively.

“Low-volatility strategies are extremely popular,” said the sellsider.

The leveraging of two of the components was facilitated by the use of proprietary indexes, he noted.

“These deals can easily be leveraged up because the structure doesn’t need capital. These are unfunded indices.

If you do two times or three times the S&P 500 there is a funding cost to do that. Someone gives you 100 and you have to buy 300. When you use these types of indices that are just hedged using futures there is no funding cost,” he said.

JPMorgan Chase

JPMorgan Chase Financial Co. LLC priced the second largest issue with $17.12 million of three-year capped enhanced participation notes linked to an unequally weighted basket of five international equity indexes. The basket consisted of the Euro Stoxx 50 index, the FTSE 100 index, the Topix index, the Swiss Market index and the S&P/ASX 200 index.

The notes offered two times exposure on the upside with no cap. Investors were fully exposed to the downside.

The top agent last week was JPMorgan with 29 deals totaling $118 million, or 45.75% of the total. It was followed by HSBC and UBS.

“You have extremely low volatility, so in general, pricing doesn’t look good. The market is range bound, near all-time highs.” – A sellsider

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