Credit Suisse's capped leveraged notes tied to Russell 2000 designed for slightly bullish play

By Emma Trincal

New York, July 31 - Credit Suisse AG, Nassau Branch's 0% Capped Leveraged Index Return Notes due August 2014 linked to the Russell 2000 index are designed for moderately bullish investors, sources said.

The payout at maturity will be par of $10 plus double any index gain, up to a maximum return of 26% to 30%. The exact cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the basket falls by up to 10% and will be exposed to any losses beyond 10%.

Jim Delaney, portfolio manager at Market Strategies Management, said that an investor would have to be only moderately bullish to profit from this note.

As long as the index does not go up by more than 13% over the next two years, investors would be outperforming the benchmark given the double leverage, he said.

He assumed a 26% cap, which would be 13% for the two-year period without the leverage.

"The sweet spot for this note is if the market is up 13% in two years. Then you achieve the most of what the note gives you. Anything less than 13% is good too. It makes it worth holding the note. But above 13%, you're better off with a Reg T account," Delaney said.

Reg T accounts refer to the Federal Reserve Board's regulation T that governs how much investors may purchase on margins.

"Now the question is two years from now, do you think the Russell will be up more than 13%?

"To me, the answer is yes. The U.S. elections will no longer be a source of uncertainty, and by then, ultimately they will have come up with a solution for what's going on in Europe.

"Whether it's going to be up or down becomes your call. But you certainly cannot be too bullish. ... This is something that pays off only if the market trades sideways," he said.

Downside exposure

On the other side of the trade, investors should not be too bearish either, he noted.

"You will outperform the benchmark because if the Russell is down 20%, you only lose 10%, if it's down 30%, you lose 20%. But given the volatility of the Russell, to me, this floor is a little tight. You could be leaving some upside for not that much of downside protection," Delaney said.

From May to October of last year, the index lost nearly 30%, he said. Then from October to April, it gained 37%.

"This thing definitely moves around a lot. We've established that pretty easily. The 10% really doesn't do a lot for you," he said.

"Instead of 10% down and 26% up, I would much rather have 15% down and 30% up or even 20% down and 40% up.

"They're capping you at 36% to 30% when you see that this index can move 37% on its own in just six months.

"So this note is definitely for an investor who doesn't expect wide moves. You can't be too bullish."

Benchmark valuation

Jack Ablin, chief investment officer of Harris Private Bank, said that his main concern is the choice of the underlying index.

"I like the structure, but if it were up to me I would use the S&P 500. It has a better valuation than the Russell right now," he said.

"We are underweight the Russell. The expectations for earnings growth in the Russell are unrealistically high. We think the Russell is probably 15% overvalued relative to the S&P.

"So if earnings go nowhere and we see very little growth in the S&P, we could easily see a 10% or 12% in the Russell over the next year or so, just on valuation."

Ablin agreed that the product is for investors who do not expect a lot of appreciation in the benchmark.

"You don't have to be very bullish. It gives you twice the upside," he said.

The product could be replicated with options, he added.

"They're buying at-the-money puts and selling 10% out-of-the-money puts on the downside. For the upside with a 26% cap, they're buying two at-the-money calls and selling two out-of-the-money calls at 13%," he said.

"That's a very simple strategy that investors can do on their own using exchange-traded options.

"This product is sold to investors who don't know much about options, and there are a lot of them.

"But it's an interesting strategy."

The notes will price in August and settle in September.

Bank of America Merrill Lynch is the agent.

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