HSBC’s jump securities tied to oil & gas ETF seen as timing call, potential big win

By Emma Trincal

New York, Dec. 23 – HSBC USA Inc.’s 0% jump securities due June 29, 2015 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund offer a 19% digital payout at maturity if the fund finishes flat or higher than its initial share price, according to an FWP filing with the Securities and Exchange Commission.

Investors, however, will be fully exposed to any decline in the share price.

Tactical bet

“This note is very attractive – it is very short term and more importantly, doesn’t require the investor to be extremely accurate about the price of oil or where the sector is heading,” said Dean Zayed, chief executive of Brookstone Capital Management LLC.

“It is more of a timing call – will the sector be higher six months from now, even if it is slightly? If so, you stand to win big here.”

For a flat or slight performance, investors may earn 19% in six months or 38% per annum, making the product appealing to a wide array of bulls but certainly not for bears, he said.

“If you think the sector is down big six months from now, you don’t make this bet. There is a real ‘timing’ and ‘have-we-hit-bottom’ element to this note.”

“I tend to think we are near the bottom. I like the digital feature. I would make a tactical bet on this sector via this note,” he said.

Oil proxy

“Although not a direct play on the price of oil, the oil and gas exploration and production companies are highly correlated with the price of oil, so any use of this ETF as an underlying should take into account an analysis on where oil is headed.”

Zayed said he was bullish on oil based on fundamentals.

“While the weakness in oil prices will probably persist into the first half of 2015, global demand continues to grow,” he said, adding that in 18 of the past 20 years, global oil consumption has increased and set new records in each of the past four years.

“This means that, unless there arises a scalable replacement for oil – and there is certainly nothing I see on the horizon – the price of oil will rebound. Shale oil production will once more become profitable.

Oil prices are trading at $57 a barrel. Zayed predicted that once oil rebounds, its floor price should be $70 a barrel, a level below which new oil product ceases to be economical.

Oil prices have plunged nearly 47% since their $107 peak in June.

“Oil cycles turn back up as demand catches back up to supply. Oil at $55 a barrel will both result in decreased supplies and increased demand. But prices overshoot during panic buying and selling.”

Huge volatility

Jonathan Tiemann, president of Tiemann Investment Advisors, LLC, said that even though the price movements in the commodity have proven to be very wide – and on the downside lately – he was still surprised by the level of volatility priced into the notes.

“It’s kind of interesting actually,” he said.

“It’s striking to me that the volatility must be so huge.

“You’re getting this 19% return on six month in any scenario of non-negative performance. If this underlying fund is flat, you get 19%. If it’s up 5%, you get 19%.

“For the issuer to be able to hedge it, you have to have a pretty good probability of a return way above 19%.

“If you take the statistical value of the non-positive return, the expected value has to be much greater than 19% or they couldn’t profitably put a hedge on it and sell it,” he said.

The only scenario in which investors lose money is when the index finishes down at maturity. On the upside, the risk would instead be an opportunity cost if the index was to perform higher than the upside payment of 19%.

Trader’s tool

“Does it mean the investor is better off being long-only? Not necessarily,” he said.

“If you expect volatility to come in lower than how it’s priced in the market, this is a good deal.

“It’s sort of a traders’ instrument. Six month is short, and you’re taking a bet not just on the direction of the index but on its volatility.

“I wouldn’t use it as a long-term investor. But it’s definitely interesting.”

The notes (Cusip: 40434F678) are expected to settle on Monday.

The 19% upside payment is a minimum. Its final value will be determined at pricing.

HSBC Securities (USA) Inc. is the agent. Morgan Stanley Wealth Management is the dealer.

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