HSBC’s one-year Stars tied to Russell 2000 offer rare bear play via autocall payout

By Emma Trincal

New York, Dec. 21 – HSBC USA Inc.’s 0% bear Strategic Accelerated Redemption Securities due January 2019 linked to the Russell 2000 index feature an untapped structure for a strategy that is already unusual: playing the market down, according to data compiled by Prospect News.

BofA Merrill Lynch will be the agent, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par of $10 plus an annualized call premium of 6% to 6.5% if the index closes at or below its initial level on the observation date, according to a prospectus. If the notes are not called, the payout at maturity will be par unless the index gains, in which case investors will lose 1% for each 1% gain in the index.

Small club

Bear notes are extremely rare, at least in any given bull market such as this year, but also in general, according to Prospect News data. Most advisers are reluctant to place directional bets on the downside, according to interviews.

Bearish offerings are limited in number and size. Only nine deals priced this year through Dec. 18 totaling $46 million, which is about 0.10% of the total notional for U.S. structured notes, according to the data.

Almost all those deals are leveraged notes that offer inverse participation in the index decline. Autocallables are rare.

But the announced deal will not be Merrill’s first bearish autocall. Eight months ago, BofA Finance LLC priced $8.75 million in bear notes autocallable similarly tied to the Russell, with call premium payments when the market falls and no downside protection when it ends higher. The main difference was its two-year maturity.

Contrarian bet

“What happens when the market goes up? And it can go up quite a bit. You lose dollar for dollar,” said Steve Doucette, financial adviser at Proctor Financial.

“You have to be confidently a bear. I can’t see myself venture in that path.”

“The market is up 20% this year. What if it’s up 20% again next year? You’re down 20%. That’s the scary part.

“I haven’t seen a note like that.”

Investors indeed must have a bearish view, although not too bearish since their return is capped by the call premium.

They have to bet on a pullback for the one-year period, accept the reinvestment risk of any call and be satisfied with the cap, warned the prospectus in its risk section.

They also must be willing to take full downside risk if the market is up.

Cap risk

Perhaps the view rather than the structure is what makes some advisers uneasy.

Losing money when the market rallies makes for a difficult conversation with a client, Doucette said.

“I can’t be comfortable with it.”

In a nine-year old bull market, wider price moves may be more likely on the downside.

“In any autocall, you don’t want a huge move since you’re capped,” he said.

“Regular autocallables are for people who are only moderately bullish and in this you’d have to be just a little bit bearish.

“But when a market turns bearish, it’s down at least 20% and you’re not capturing anything close on the upside.”

No bear in sight

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he would not consider the trade.

“It’s popular to be bullish based on how much the market has run up. But economic growth is also a driver,” he said.

“Today getting a final reading on the GDP at 3.2% is pretty encouraging. I don’t see any indication that the market should go down.

“Theoretically and statistically you could say it could eventually. But this note is a pretty specific bet.

“You have to be bearish and you have to make the right call since there is no protection.

“I think if you’re concerned about a market pullback, there are probably more prudent ways to protect your downside.

“It’s a risky call if you’re trying to generate an absolute return.”

Refreshing

A market participant said the notes caught his attention.

“I actually like it: it is healthy to see investors being able to express a bearish view with an autocall type payout,” he said.

“Structured products should be viewpoint-agnostic: you have a view, we can help you capitalize on it!”

The notes are expected to price and settle in December.

The exact call premium will be set at pricing.

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