Morgan Stanley’s inverse participation notes on S&P offer short-term, purely bearish bet

By Emma Trincal

New York, Feb. 27 – Morgan Stanley Finance LLC’s 0% bearish buffered participation securities due April 1, 2021 linked to the S&P 500 index provide capped one-to-one participation in the index decline with a limited buffered protection if the market ends up being bullish, according to a 424B2 filing with the Securities and Exchange Commission.

Unlike absolute return products seen in the market lately, this note only offers a positive return in a declining market.

If the final index value is less than the initial index value, the payout will be par plus 1% for every 1% decline of the index, capped at par plus 12.8%.

If the final index value is greater than or equal to the initial index value but has increased from the initial index value by an amount less than or equal to the buffer amount of 5%, the payout will be par.

If the final index value is greater than the initial index value and has increased from the initial index value by an amount greater than the buffer amount, investors will lose 1% for every 1% increase beyond the buffer.

Rally risk

“It’s a short-term play. 12.8% is not bad over a 15-month period. But you have to be damn sure the market is not going to be up,” said Steve Doucette, financial adviser at Proctor Financial.

“If the index moves up and starts to go crazy, how do you unwind this note? How do you get out?”

He said he bought a note, which paid a small return of less than 3% if the S&P 500 index finished positive.

If it dropped, investors were to get a leveraged absolute return from 100% to 60%. The 40 points range operated as a buffer.

The 2.5-year note was issued by BNP Paribas.

“With this note we bought back in December, you were not getting much if the market was up but at least you were not losing money on the upside. This one can make you lose a lot of money because 5% is not a big buffer, “he said.

On the other hand, the Morgan Stanley deal does not expose investors to any losses if the index is down. Their gains are merely capped.

One-directional

“This one is much more bearish than the one we did,” he added.

“With the BNP note, you could lose money on the downside but the market would need to drop more than 40%. 40% is a big buffer. At least you had the opportunity to make money both ways.

“This one is purely bearish. It’s a one-direction bet. You have no return on the upside. The only way you’re going to make money is if the market is down.

“I can’t have full confidence that the market will be down in 15 months. What if they can contain the virus by then? Stocks will be off to the races.

“I don’t want to give up the upside entirely.”

Too late

A market participant objected to the timing although he said the note was “interesting.”

“They should have done that a week ago,” he said.

When making a bearish bet, investors are better of entering the trade when prices are high, just as buying at a lower level makes more sense and reduces the risk, he explained.

On Thursday, the S&P 500 index entered correction territory down 10% from last week’s record high amid rising concerns about the escalating number of coronavirus cases outside of China.

Meanwhile, the Dow Jones industrial average dropped nearly 3,000 points since Friday. The benchmark also fell by 10% from its mid-February high in a six-day sell-off.

Limited cap

This market participant said his main criticism was the limitation of the return if the index finished negative.

“They’re giving you a 12.8% cap on the downside. The market could be down much more than that,” he said.

“You could see a drop twice or three times as much as that.”

In addition, the 5% buffer if the market turned back up was not much in his view.

“Having more than 5% for a buffer would be preferable although not essential.

“Mainly my concerns are the timing and the cap. You should be able to make more than that in a bear market,” he said.

There have been 25 bear markets in the S&P 500 index since 1929, according to Ned Davis Research. The average length has been 299 days. Prices on average have dropped 35.68%.

The notes are guaranteed by Morgan Stanley.

The underwriter is Morgan Stanley & Co. LLC. The dealer is Morgan Stanley Wealth Management.

The notes will price on Friday.

The Cusip number is 61770G401.

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