Barclays' $32 million leveraged buffered notes tied to S&P 500 drew strong bid in rich market

By Emma Trincal

New York, March 14 - Barclays Bank plc's $32 million of 0% buffered return enhanced notes due March 27, 2013 linked to the S&P 500 index ranked No. 1 in size last week. Sources said investors are hungry for enhanced returns with buffers, and the notes combine leverage and downside protection with a short duration.

But despite the appealing structure, the overbought market presents too much risk, a trader said.

The payout at maturity will be par plus double any gain in the index, up to a maximum return of 12.4%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will lose 1.1111% for every 1% decline beyond 10%.

Good tenor

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said that he likes the enhanced return potential as investors get twice the appreciation of the index up to the cap.

"Not bad for a one year," he said.

"In that timeframe, all you need is the S&P 500 to rise by 6.2%. Anything above that would be lost, but you get your full return.

"I see why it was the No. 1 sale. There's a fair probability of hitting the cap because of the reasonable chance of seeing the market go up 6% in the next 12 months.

"At least you get a 10% protection on the downside if you're wrong."

Pool said that if the deal had not already priced, "we would be interested in that."

He said his firm focuses on 15% buffers because it caters to conservative clients. But the 10% buffer on a one-year tenor is attractive, he said, adding that he buys structured notes in tenors ranging from 12 or 14 months up to two years.

"We want to be on the short side in this environment," he said.

"For two-year duration, we want bigger buffers or twin-win notes."

Twin-win notes, also called dual directional or absolute return notes, offer investors a positive return regardless of the direction of the market as long as the underlying price decline does not breach a specific barrier.

For a two-year leveraged buffered note, Pool said that he wants much more protection.

"We look for 25% buffers on that term, but you can't find them. Right now, 20% would be the best you could get on a two-year," he said.

One negative aspect of the structure of the Barclays notes, Pool noted, is the 1.1111 downside leverage.

"I'm not a big fan of that because if you go beyond the 10% and keep going down and down, losses begin to accumulate and you can lose your entire principal," he said.

"But here again, the saving grace is the relatively short duration."

Entry point

Clemens Kownatzki, a Los Angeles-based independent currency and options trader, said that the upside leverage is appealing. But as the market has moved higher, a 10% downside buffer may not be sufficient to mitigate risk.

"The appeal is obviously that you have this enhanced return on the upside," he said.

"But I don't like the unlimited downside once you pass the 10%.

"It looks similar to selling a put option. As long as the market is at current level or above, you can get enhanced gains. You can keep your premium, which is your cap. You know in advance your maximum profit.

"However, once prices begin to drop, you start to be exposed to a lot of risk given today's levels."

Kownatzki said that last year offered an example of a sudden sell-off, which caught many investors off guard.

"If this year looks similar to last year when the market in August dropped by 19% in just a few weeks, you're exposed to quite a bit of downside," he said.

"The S&P 500 is almost at 1,400. People are buying a lot of puts.

"It's a risky structure."

Kownatzki said that if he had to buy the notes, he would use them to hedge an existing exposure.

In addition, he would look for "more cost-effective" alternatives.

"I could just be buying put options or short the S&P 500. I could even use one of those inverse ETFs if I really wanted an equity hedge," he said.

Barclays Capital Inc. was the agent with JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC acting as dealers.

The fees were 1%.

The Cusip number is 06738KW72.

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