Morgan Stanley’s trigger PLUS tied to Health Care Select SPDR show rarely used ETF, sector bet

By Emma Trincal

New York, Dec. 2 – Morgan Stanley Finance LLC plans to price 0% trigger Performance Leveraged Upside Securities due Dec. 28, 2021 linked to the Health Care Select Sector SPDR fund, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be guaranteed by Morgan Stanley.

The payout at maturity will be par plus 125% of any gain in the fund. Investors will receive par if the fund falls by up to 30% and will be fully exposed to any losses if the fund finishes below the 70% trigger level.

Rare underlying

“This is not a widely used ETF. I assume they had some kind of thesis on health care for choosing this sector,” a market participant said.

The Health Care Select Sector SPDR fund tracks the health-care sector as a whole. Among its top holdings are drug manufacturers (Johnson & Johnson, Pfizer, Merck), large insurance companies (UnitedHealth Group, Aetna) and biotech companies (Amgen, Gilead Sciences and Celgene), among others.

Very few offerings – four in total amounting to $3.73 million – have been linked to this underlying fund so far this year, according to data compiled by Prospect News. Two were issued this fall by Credit Suisse AG, London Branch: a $1.79 million issue distributed by UBS and a $605,000 deal sold by JPMorgan. Separately, JPMorgan Chase Bank, NA issued $870,000 of CDs in late March, and HSBC USA, Inc. did the most recent one for $460,000 at the end of October.

Theme

“Perhaps the view is that this particular sector is going to benefit from the incoming administration if they do what they said they would do with the Affordable Care Act,” this market participant said.

Regardless of the investment theme, structures allowing investors to express a particular idea are becoming more widespread, he said.

To do that, investors may use proprietary indexes or sector funds, he said.

This note tied a widely traded ETF was designed to provide leverage and protection while some other theme-based strategies, for instance stock-picking strategies, will be using delta-one exposure with baskets of selected stocks as underliers, he added.

Trade-off

Getting leverage with protection and no cap remains the focus of many advisers. But the package may be expensive to price and requires some compromises, said Clemens Kownatzki, an independent currency and options trader.

“It’s a trade-off. People tend to go to the product they’re the most used to. They like leverage, but they don’t want the cap, so extending the maturity makes sense,” he said.

Diversified portfolio

The notes are effective for a strongly bullish investor, he added.

“I can see the bullish point of view: leverage, no cap. In this environment that we have after the elections, there’s a lot of talk about changes in the said.

“I can see the rationale behind the deal. We assume that Trump is going to change Obamacare completely, although it may not happen so drastically. But the rationale behind it is that less regulation will be a boost for the sector.

“If that’s the view, I can see the advantage of the upside leverage, no question.”

Kownatzki said that diversification is one of the advantages of using a sector ETF.

“There’s so much uncertainty. You can have so many winners and losers. No one can look at the top holdings of this fund and pick the best stocks without having a solid knowledge of the sector. So spreading the risk in a diversified portfolio is a good strategy,” he said.

Tenor, risk

Kownatzki, however, said he had two “concerns” about the notes.

The first one was its length.

“I have to wait for five years. In five years, a lot of things can happen including a new administration. I have a problem with that,” he said.

The second “problem” was the downside protection.

“After a 30% decline, I’m exposed to the full downside. Within the next five years we could have a crisis. It’s like having no protection because once you breach the barrier you’re long the ETF.”

Rather than having credit risk exposure and risking a loss of at least 30% in principal, he said he would buy the ETF outright or purchase a call option on the fund.

A better option

“If you have a bullish view on this sector and if you’re a long-term strategist, you have many ways to express your view,” he said.

Using an option would be is favorite choice.

He would buy an out-of-the money call on the ETF in a two-year contract. Call options that trade on the exchange tend to be short term, he explained, adding that a two-year contract would be the longest available contract.

Since the option is out-of-the-money (the strike price for the call is higher than the current price), the cost would be moderate as the risk of not seeing the stock rise above the strike is greater. In addition, his downside risk would not exceed the premium he would receive.

“If I’m bullish, I give myself two years. If I am right, I get the full upside. If I’m wrong, I have a limited downside,” he said.

“I would be much more comfortable with that.”

Morgan Stanley & Co. LLC is the agent.

The notes will price on Dec. 22 and settle on Dec. 28.

The Cusip number is 61768CCQ8.

© 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.