Morgan Stanley’s buffered PLUS linked to Russell 2000 would outperform in range-bound market

By Emma Trincal

New York, Aug. 26 – Morgan Stanley’s 0% buffered Performance Leveraged Upside Securities due March 3, 2016 linked to the Russell 2000 index are designed for investors seeking to outperform the index in a moderately bullish scenario. The notes, however, would not be suitable if the small-cap market were to move beyond a certain range, sources noted.

The payout at maturity will be par plus 200% of any index gain up to a cap of 13.22%. Investors will receive par if the index falls by up to 10% and will be exposed to any losses beyond the 10% buffer, according to an FWP filing with the Securities and Exchange Commission.

Sources said the notes could offer an attractive alternative to an investment in the index as long as the underlying performs within a range.

On the downside, the range would be defined as any loss smaller than 10%. On the upside, the gains would have to be limited to 6.61% for the term, which would represent the maximum value of 13.22% once the leverage is applied.

Specific view

“This deal satisfies an investor’s perspective which would be, obviously, mildly bullish or mildly bearish. It doesn’t really represent the extreme conviction that we’re going to have a huge run-up or a huge correction,” said Dean Zayed, chief executive officer at Brookstone Capital Management.

“The terms are solid, but they are geared toward a particular perspective. It works for you if you want to get exposure to the index and if you don’t expect too much of a correction. If the market is down 5% or 10%, it gives you just the right cushion.”

The two-times leverage factor lets investors get a desired level of exposure with less cash, according to the prospectus.

“Leverage is good of course, but there is only so much you can get here. The cap takes care of the higher aspirations,” he said.

The 13.22% cap over 18 months represents an annualized return of 8.65% on a compounded basis. The index would need to rise by only 4.35% a year in order for investors to maximize their return, he noted.

Russell 2000 lagging

Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, noticed the performance gap between the Russell 2000 index and the S&P 500 index.

The Russell 2000, which tracks the small-cap segment of the U.S. equity market, is up 1.25% this year, compared with 8.25% for the large-cap benchmark.

“It’s been a funny market. Large caps have done much better than smaller caps,” Tiemann said.

“One thing that’s a little weird with this deal is that if you’re so concerned that there is not much upside potential on the Russell, why would you settle for a 10% buffer on the downside?

“I guess it makes sense if you see the index trading range bound during the period.

“You do end up much better off than the index if it stays in that range, between minus 10% and plus 13%.

“If the underlying index falls a bit, you’re much better off. But if it goes to the moon, you really sacrificed a lot. It’s really for someone who sees this index trading sideways for the next 18 months.”

Tiemann said the structure replicates a few option positions including a long put, which provided the buffer, some long calls for the leveraged upside and a short position on the calls at a strike level that coincides with the cap. As with any call writer, investors in the notes would have to give up any gains above the cap, he said.

“Somebody has a view that over the next 18 months, the Russell 2000 is going to be pretty aimless,” he said.

“What would be interesting would be to see how you may combine this trade with a long position in the S&P 500.

“If you think that the large-cap market is too far ahead of itself and likely to fall back while the Russell is just about at the right place ... that might work.”

Morgan Stanley & Co. LLC is the underwriter.

The notes were scheduled to price Wednesday and will settle Sept. 2.

The Cusip number is 61761JSQ3.

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