RBC attracted contrarian bid with its $11.59 million of bear Stars linked to Russell 2000

By Emma Trincal

New York, Aug. 29 - Royal Bank of Canada brought to market a bear note with its $11.59 million of 0% bear Strategic Accelerated Redemption Securities due Feb. 25, 2013 linked to the Russell 2000 index, the No. 3 deal last week in size in the form of a somewhat out-of-favor category of products, sources said.

The offering, albeit small, was noteworthy because the market sentiment remains overwhelmingly bullish, they noted.

If the final index level is less than or equal to the initial index level, the notes will be called and investors will receive an 8.85% call premium.

If the notes are not called, investors will lose an amount equal to the index gain.

Asymmetrical payout

"I think it's a very, very risky trade," an industry source said.

"It's probably priced pretty fairly. I just think it's a little bit crazy. The most they can make is 8.85% if the market is down, and they can lose everything if it's up.

"You're better off buying a put option, pay your premium and limit your risk to the premium.

"They are writing a call spread on the Russell, using the premium to buy an at-the-money digital put option.

"Besides not having an option account, I don't know why anybody would want to be short the market to make 8%.

"They may have wanted to hedge a long position on the Russell. It has to be a one-off."

A market participant said that it is not totally surprising to see a bear note as the market enters the fourth month of its enduring rally. Since June 1, the S&P 500 has gained a little bit over 10%.

"People for now are still bullish, but this note offers you a nice return for taking the opposite view," this market participant said.

"As people start to think that the market is topping, we might see more of these.

"Personally, I'm a proponent of these types of bear deals, but from a selling perspective, it's hard to sell to a client because they have to understand that they will lose money when the market goes up. That's tricky. You really have to explain it, because a client who loses money when the market is up is going to feel very foolish. That's where the risk lies."

High premium

While the notes do not offer any downside protection in a rising market, the risk/reward profile of the product is still compelling, he noted.

"That's great. Where else can you get that type of yield, 8.85%, after six months? Of course there is risk, but you're taking a short position on the index," he said.

This market participant explained that one of the attractive aspects of the deal is the enhanced return potential. Even if the index ends lower by a fraction of a percent, investors will see their return bumped up to the 8.85% digital return. On the downside, the losses would just be proportional to the index's advance on a one-for-one basis, he added.

Investors in this note may reduce the risk by investing only a small portion of their portfolio into it or by making sure that the overall portfolio is hedged and balanced, the market participant said.

Bank of America Merrill Lynch was the underwriter.

The notes (Cusip: 78008B293) carried a 1% fee.

© 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.