HSBC’s autocall tied to Nvidia stock offer defensive call level, likely short play

By Emma Trincal

New York, March 29 – HSBC USA Inc.’s 0% autocallable securities due April 1, 2021 linked to the common stock of Nvidia Corp. show high probabilities of an early redemption as the trigger for the call is 10% below the initial price, said Almudena Rojas, structured products analyst at Future Value Consultants.

If the shares close at or above the downside threshold, 90% of the initial price, on any quarterly call observation date, the securities will be automatically redeemed at par of $10 plus a call premium giving a return of at least 11% per year, according to an FWP filing with the Securities and Exchange Commission.

If the final share price is greater than or equal to the 90% downside threshold level, the payout at maturity will be par plus 33%.

Otherwise, investors will lose 1% for every 1% that the final share price is less than the initial share price.

Conservative and short

“This product is a defensive autocall,” said Rojas.

“It’s unusual to have a call level below 100. But by doing that, the issuer is able to raise the probability of a kick-out event especially at the end of the first quarter.

“The chances to see this investment extend to its maturity date are very slim.”

Investors buying the notes should anticipate a 2.75% coupon and three-month duration as the most likely scenario.

“You shouldn’t expect to get the full 11% coupon during the three years,” she said.

“From the issuer’s standpoint, an 11% coupon is high but it’s likely to call especially with this volatile underlying, so that’s how they can price it.”

Stress testing

She illustrated her observations using the stress testing methodology employed by Future Value Consultants. The firm specializes in generating stress testing reports for structured notes.

“The high likelihood of calling and calling early are reflected in the report for this note,” she said.

One of the 29 tables or tests which are displayed in each report is the investor scorecard.

The test consists of a number of different mutually exclusive outcomes of product performance. It shows outcome names, probability of occurrence, average return and average duration. The different outcomes vary by product type and product terms.

For instance, in the case of this autocallable product, the outcomes are: probabilities of call for each of the 12 call dates, probability of full capital return and probabilities of capital loss.

A Monte Carlo simulation generates the probabilities for each of those outcomes. Their sum will add up to 100%.

Whole is zero

Investors in this note, she explained, can either make money when they receive a call premium upon the kick-out event or they can lose capital if the notes are not called due to a price decline in excess of 10% at maturity.

That leaves no room for a return of 100% of principal.

“The full capital outcome has a 0% probability,” she said.

Therefore the probabilities are distributed between the 12 call points on the positive side and the capital loss outcome on the negative side.

Quick exit

Nearly 70% of the time (69.3%), the notes will be automatically called on the first observation date, according to the scorecard.

When adding the probabilities for a call on the second, third and fourth quarter (8.13%, 3.91% and 2.22% respectively), one finds a probability of nearly 85% to be called on the first year, she said.

“It’s very high. Once you go further in time, those probabilities become very small...from 1.36% on the fifth observation to 0.36% on the call at point 12,” she said.

The chance of capital loss, which happens only when there is no call, is only 10.8%, according to the scorecard.

“This is a product that will definitely give you a return,” she said.

“Your probability of getting an excess return is nearly 90%,” she said.

“In other words, it’s quite difficult to lose money with this product because you will kick out early.”

Payout

Another table named “capital performance” shows the average payout for each outcome: return more than capital and return less than capital.

When investors get paid a premium, the average payout is 104.6%.

“It is not very high but it is very likely to happen,” she said.

The chances and size of losses are just on the opposite end of the spectrum. While it will happen less than 11% of the time, the average loss is 57.5%.

Implied volatility

The underlying stock has an implied volatility of 38%, according to the report.

“It’s quite high, which can be an advantage as it increases the chance of being called,” she said.

Last week’s sell-off in the technology sector put downward pressure on the stock, one of the best performers in the sector. In addition, the company was hit by negative headlines leading it to halt self-driving tests. On Wednesday alone, the share price fell 12%.

Rojas explained that the simulation is price-neutral even if volatility is a major factor in the model.

“Our model will take into account increase in volatility,” she said.

“However, we don’t draw conclusions about the future direction of the price based on recent sell-offs. The drop may be an opportunity or it could go down even more next week. There’s no guarantee it’s going to snap back. We’re not taking a view.”

European barrier

The notes offer a high probability of short-term income. There is however some risk if the notes are not called however unlikely this outcome may be.

This led Rojas to consider the 90% as the principal repayment barrier at maturity.

“There is a lot of value in knowing that you’re probably going to kick out. No matter how soon it happens, the 11% annualized return is very attractive,” she said.

Having a defensive call trigger helped achieve those terms.

But when the notes are not called investors will lose a large amount of capital even if the odds of such outcome are slim. This is the reverse impact of the 90% barrier.

“A lot of other autocallables may have had a 60% or 70% barrier. Ten percent on that volatile stock is not all that much. It is missing. But if you had put it in there it would have significantly reduced your yield,” she said.

HSBC Securities (USA) Inc. is the agent, with Morgan Stanley Wealth Management handling distribution.

The notes will settle on April 4.

The Cusip number is 40435M664.

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