Morgan Stanley’s jump notes linked to S&P GSCI Crude Oil to outperform in slow oil recovery

By Emma Trincal

New York, March 23 – Morgan Stanley’s 0% jump securities due September 2016 linked to the S&P GSCI Crude Oil Index – Excess Return offer a fixed return if the index finishes flat or positive, making the payout, or “jump,” especially attractive in the event of a moderate recovery in oil prices, sources said.

If the index finishes at or above the initial level, the payout at maturity will be par plus an upside payment of 25%. Investors will be exposed to any losses, according to a 424B2 filing with the Securities and Exchange Commission.

Modest bull

“For someone who has a modest view on oil over the next year and a half, it makes sense,” said Steven Foldes, vice chairman of Evensky & Katz / Foldes Financial Wealth Management.

“This is actually an interesting note because obviously advisers would like to take advantage of the low cost of oil, but we don’t know if it’s going to go lower or appreciate, and we don’t know the timing of that.

“So if someone expects oil prices to recover at a moderate pace, it makes sense. Sixteen percent a year is not bad.

“But you wouldn’t use this note if you were really bullish because this fixed payment is a cap. If you expected a big increase, you wouldn’t want to be capped out even at 16%.”

Jump

Foldes said that he doesn’t like caps in general.

“But this is not the case here,” he noted, pointing to the digital payout, which is paid as long as the index does not drop at maturity.

“This is a little bit different. It’s not like a participation note.

“Yes, with this product, you’ll be penalized if the index soars. But it’s a jump note. If the index is up only 1%, you make 25%. That’s the trade-off.

“This note could take a very small return and expand it to a major one.

“But you have to have a modestly bullish view. You can’t be very bullish.”

Entry price

Foldes saw in the notes’ full downside exposure to oil a lesser problem than with notes tied to other asset classes since oil has already experienced a “precipitous fall.”

“There is no downside protection, but at these levels, it is not as significant as when oil was trading at $100 last summer,” he said.

“Oil has already fallen by more than half, so the downside protection is nearly not as relevant as what it was a year ago.

“As long as you’re not bearish and as long as you’re not extremely bullish, it makes a lot of sense.”

No protection

Matthew Bradbard, vice president of managed futures and alternatives at RCM Asset Management, said that the full downside risk and lack of liquidity are not appealing.

“The big concern, as always, is the no protection on the downside,” he said.

“We’ve had a brutal bear market in oil, and maybe most of the damage has been done. Maybe we’re closer to the bottom than we are to the top.”

But the market is still uncertain.

“With all the geopolitical events that are happening and with the dollar that has been on a tear lately it’s hard to predict what’s next.”

He said that most of the dollar appreciation is likely to have “already been priced in” but that many other factors can influence the commodity price.

“Oil depends on a lot on fundamentals – supply, rig counts, lack of demand. Any geopolitical news can have an impact. Anything happening in the Middle East or in Russia can have an impact.”

Liquidity

Bradbard said that he has no exposure to oil at the present time.

“I’m not bullish or bearish. Oil probably has a limited upside and a limited downside. But it’s right now, not a year and a half from now,” he said.

“My concern with this note is that my upside is capped and my downside is not capped. I’d rather have it the other way around: no cap on the upside and a capped downside. In this case, the terms would be good.”

Limited trading in the secondary markets is also a concern.

“With oil, you can see a $10 or $15 spike or a $10 or $15 decline any time. I want to be able to get out of there in a quarter or two,” he said.

The notes (Cusip: 61762GDN1) will price and settle in March.

Morgan Stanley & Co. LLC is the agent.

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