Morgan Stanley’s $1.7 million bearish notes on S&P offer inverse exposure with 85% protection

By Emma Trincal

New York, Nov. 13 – Morgan Stanley Finance LLC’s $1.7 million of 0% bearish equity-linked partial principal at risk securities due May 5, 2022 linked to the S&P 500 index provide investors with a tool to express a bearish view while keeping up to 85% of their principal protected “against” a rally, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is negative, the payout at maturity will be par plus 1% for every 1% that the index declines from its initial level, capped at par plus 50%.

If the index return is flat or positive, investors will lose 1% for every 1% that the index increases from its initial level, subject to a minimum payout of 85% of par.

Too long for a bear

Ed Condon, director of national sales at MCG Securities, said it’s rare when investors show appetite for bear notes.

“It’s interesting. But in general, advisers and clients don’t want to bet against the market for a long period of time,” he said.

The tenor was too long for a bearish trade, he added.

“You have to remember that gains aren’t fully realized until maturity. That’s two-and-a-half years from now.

“By owning that note, you’re taking a bearish position on the market two-and-a-half years from today.

“I think the note is a bit too long.”

Unleveraged hedge

Investors buy bearish notes when they are trying to hedge or protect portions of their portfolios through a tactical approach, he added.

“Is this one a good hedge? Probably not.

“There are cheaper ways to do it like buying puts.”

With U.S. markets at all-time highs, the cost of put options is expensive, he conceded.

“But people constructing that note have to buy this expensive put too. You’re buying it one way or the other,” he said, referring to the terms offered to investors as they reflect the cost to the issuer.

The one-to-one participation in the market decline was perhaps another drawback.

“If you buy a put, at least you’re getting leverage. You have to put a lot more money down with the note.”

Having 85% of principal protected was attractive. But investors are subject to the first 15% losses on a one-to-one basis if the benchmark finishes positive, he said.

“You could have a market decline in the next six months and be back up at or above today’s levels.

“The real problem with this note is the two-and-a-half year out,” he said.

Asymmetrical payout

Andrew Valentine Pool, main trader at Regatta Research & Money Management, had a different take on the duration, pointing to what he considered to be a relatively short-term bet.

“These notes serve a purpose, especially now as the market is so toppish,” he said.

Investors, he noted, are allowed to profit from a market decline with gains capped at 50%,” he noted.

A rally on the other hand cuts their losses to a maximum of 15%.

This asymmetrical outcome created an attractive risk/reward ratio.

“The market could be down 20% or 25% and that’s your gain. That’s not bad because your potential gain is slightly better than your risk as far as the market going up.”

The 2.5-year timeframe seemed appropriate to accommodate various back-and-forth market scenarios, in his view.

Slow recovery, fast drop

“The market could continue to rally and then drop. That may give you a chance to profit from the inverse exposure to the index,” he said.

On the other hand, if stock prices were to fall within the next 12 months, a substantial gain would be required to break even.

“That’s how it works. If the market retreats 20%, it would have to shift and go up by 25% just to go back to break even.

“Compounding works in your favor in this case.”

Since bear markets tend to post deep price declines in a relatively short period of time, it may be possible to imagine (although impossible to predict) that the ensuing recovery may be interrupted or even avoided altogether.

“I like that it’s short-term. If we have a pullback in 12 months, that would put the maturity in alignment with the average length of a market pullback,” he said.

Bear markets have lasted 14 months on average since World War II.

“This note, depending on an adviser’s outlook, may have a place in a portfolio,” he said.

The notes are guaranteed by Morgan Stanley.

The underwriter is Morgan Stanley & Co. LLC.

The notes (Cusip: 61769HL78) priced on Nov. 1.

The fee is 0.25%.

© 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.