Morgan Stanley's dual directional notes tied to S&P 500 to appeal to long-term holders only

By Emma Trincal

New York, June 24 - Morgan Stanley's 0% dual directional trigger Performance Leveraged Upside Securities due July 2020 linked to the S&P 500 index should appeal to long-term investors looking for alternatives to a direct investment in the market, a financial adviser said.

However, the absolute return feature - despite its appeal - carries some risks, which may not be easy to manage, said another adviser.

If the index finishes above the initial level, the payout at maturity will be par of $10 plus 143.25% to 146.25% of the index return, according to a 424B2 filing with the Securities and Exchange Commission.

The exact amount will be set at pricing.

If the index falls by up to the 60% trigger level, the payout will be par plus the absolute value of the return, up to a maximum return of 40%.

If the index falls by more than 40%, investors will be fully exposed to any losses.

Good trade-off

"I'm not a big fan of long-term holding periods, especially right now. I don't like the fact that it's seven years. That's too long," said Kirk Chisholm, principal and wealth manager of NUA Advisors.

"That said, I do like the risk-reward balance. In this deal, it looks like it's heavily in favor of the reward versus the risk, which is usually not how it works. So that's puzzling.

"The benefit is obviously if the S&P is down but down less than 40% at the end of the term [...] that gives you a pretty good return. And you have an amplified upside with no cap. That's a nice feature too.

"In my opinion, if my strategy is to be long the index for the next seven years, then this note would be a much better alternative than holding the index directly," Chisholm stated.

Alternative to the index

"You're getting amplified return on the upside, you're limiting the first 40% losses - in fact, you're getting gains from it. If the index is down by more than 40%, you wouldn't lose more than if you had held the index outright in the first place," he said.

Chisholm said that the trade-off was the fact that investors had to forgo dividends.

"But you're getting all the other features for that. In my opinion, it's a clear winner," he said.

Chisholm said that he would not invest in the notes, however, because of the long tenor, adding that liquidity would be a challenge.

"But for people who have a buy-and-hold philosophy and who believe in investing in indexes for the long-term, something like that would make sense," he said.

Jonathan Tiemann, president of Tiemann Investment Advisors, LLC, said that the absolute return component of the structure, despite its appeal, may turn out to be a difficult feature to hedge.

High-risk delta

"It's an interesting structure although you don't have the liquidity," the wealth manager said.

"It's cute [...] My biggest issue is the volatility. If you're down near that lower range, then the volatility of the net result is huge. It's certainly a risk to be able to make 40% and lose 41% with just one point difference in the index decline. The volatility is extreme when you're near that 40% barrier and it's not a valuable volatility for you. You're not getting paid for it. There's a discontinuity in the outcome. It's high-risk delta," he said.

"On the upside, all you have is a leveraged play on the S&P and that's all right.

"But on the downside, the closer you get to that trigger, the more difficult for you it is to manage and to hedge the risk. It's hard to evaluate what your risk and opportunity really is.

"One advantage may be that the barrier is final. Nothing happens in between. It's certainly better for the investors from that standpoint," he added.

Morgan Stanley & Co. LLC is the agent.

The notes will price in June and settle in July.

The Cusip number is 61762E786.

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