Bank of America's $90.69 million leveraged notes tied to S&P 500 show bulls' resilience

By Emma Trincal

New York, Oct. 31 - Bank of America Corp.'s $90.69 million of 0% Accelerated Return Notes due Oct. 31, 2014 tied to the S&P 500 index suggested that investors have a strong appetite for leveraged notes even with no downside protection, a sign that the bullish momentum has remained intact, sources said.

According to preliminary data compiled by Prospect News, the notes topped the list of deals that priced last week. Figures are subject to change as the data compiled on Tuesday was delayed due to disruption caused by Hurricane Sandy.

If the index return is positive, the payout at maturity will be par plus 300% of the index return, subject to a maximum payout of par plus 19.77%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will lose 1% for every 1% decline in the index.

Popular deal

An industry source said that the offering was very popular given its size.

But he said he was "not sure why" people would buy a product with no downside protection at this time.

"I guess it's a combination of the bullish sentiment post the recent selloff. It gives you a good entry point and the three-times leverage makes the upside somewhat attractive," this source said.

A market participant said that investors like simplicity and that this product was straightforward and easy to understand.

"It's more a factor of plain vanilla transaction. It's the kind of core investment that people like," he said.

The upside potential with nearly 10% cap per year must have been attractive to investors as well, he said.

"Investors feel there is a reasonable return for the amount of risk they're taking. That's what everybody is looking for right now: a good risk reward profile," this market participant said.

Options alternative

But for some buysiders, using options instead of a structured note may give investors a better risk return profile at a lower cost.

"I think you can sort of replicate this by buying deep-in-the-money calls on the S&P," said Steven Jon Kaplan, founder and portfolio manager of the Contrarian Investments LLC.

He gave a quick example using the S&P 500 at a price of 1400.

"You buy deep-in-the-money calls with a 1200 strike. They're not going to cost you much more than the $200 intrinsic value that you already hold. There may be a small time premium because the S&P 500 is quite liquid. But if you use the Russell 2000 or another market index somewhat less known than the S&P, you can reduce it," he said.

A deep-in-the-money call is one with a strike price - 1200 in Kaplan's scenario - significantly lower than the current price of the reference asset, which is 1400 in the example.

"If the S&P goes up to 1500, your intrinsic value increases from 200 to 300. That's a huge leverage.

"If it goes the other way, your loss is your $200 premium but at least you know how your maximum loss is. With the notes, you don't," he said.

Kaplan said that a bearish investor could do exactly the same thing by buying deep-in-the-money puts and leveraging up return as the market goes down.

"The advantage of putting together the options yourself is that ultimately, it's going to be cheaper than buying if from an issuer who packages those contracts for you," he said.

"Options have a different kind of decay. It's cheaper, more liquid and you are not subject to a credit event."

Kaplan said that his strategy of being long deep-in-the-money calls offered the additional benefit of a better risk return.

"Your return is not capped and that's a big advantage over those notes," he said.

"This product gives you a 20% cap on the upside but there is no downside protection. By definition, this is a problem for the investor."

"With the options, you can get the leverage that you want and limit your losses to your premium without limiting your upside," he said.

The notes (Cusip: 06053D542) priced on Friday.

The fee was 2%.

Merrill Lynch & Co. was the underwriter.

© 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.