BMO’s 10.14% one-year notes tied to Gold Miners offers vol. rather than directional bet

By Emma Trincal

New York, Oct. 24 – Bank of Montreal’s 10.14% autocallable cash-settled notes with fixed interest payments due Nov. 30, 2018 linked to the VanEck Vectors Gold Miners exchange-traded fund allows investors who anticipate limited upside in the sector to lock in a guaranteed coupon payment along with some downside protection, said buysiders.

Interest will be payable monthly.

The notes will be called at par plus the coupon if the fund closes above the 110% call level on any monthly call date beginning April 25, 2018, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus the coupon due unless the fund finishes below its initial level and closes below the 75% trigger price during the life of the notes, in which case investors will lose 1% for each 1% decline.

Short a call

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the pricing of the notes was probably fair. The product is the equivalent of selling a call option on the underlying fund.

While there is no one-year call on the ETF, he presumed that the option premium paid to the writer of the call would be “in the ballpark” with the interest paid on the notes.

Aside from the premium, a comparison between the notes and a short call position was difficult because of certain characteristics of the structured note such as the contingent protection and the differences in liquidity between the two derivative instruments.

The autocall option was different from most autocallable structured notes due to a higher trigger at 110% compared to the initial price, which is standard. This gave investors a chance to earn the coupon for a longer period of time, he noted, although he added that: “I’m still not a fan of autocalls in general.”

The six-month “no-call” added an additional protection for income investors who are eager to collect their coupon as long as possible.

A different view

Chisholm proceeded to compare the notes with a long position in the ETF.

“If you think the Miners are going to stay flat for a year, or at least won’t be up more than 10%, then it’s totally reasonable to buy the note,” he said.

“It allows you to make that bet while giving you a 25% protection which is very decent if you’re concerned about the downside risk.”

But this would just not be his view.

“The sector has been beaten up for sometime. It’s consolidating. It’s close to a time where it can start moving in a positive direction.

“This ETF I believe has a lot more upside potential than it has the downside.

“That’s why the protection doesn’t appeal to me.”

But some investors may not have such a clear outlook or may not be as bullish, he added.

“If you don’t have a specific view, if you look at the ETF not knowing where it’s going, this product has nice benefits.

“But because I believe there is upside potential here I would be much better off owning the stock outright than buying this note,” he said.

Capping the hedge

Jonathan Tiemann, founder of Tiemann Investment Advisors, said that the notes would not allow investors to use the gold-related underlying as a hedge.

“You’re not really making a directional bet on GDX. Your view is on the volatility of the ETF. You’re betting that volatility will stay modest,” he said.

The VanEck Vectors Gold Miners ETF is listed on the NYSE Arca under the symbol “GDX.”

If the bet proves to be the wrong one and gold prices decline, causing the ETF to fall in price too, investors can benefit from the defensive structure, he said.

“Your protection on the downside seems pretty attractive.

“But if we’re going into a crisis and North Korea is one of many things that could happen, you won’t be able to hedge your equity portfolio with gold or gold-related stocks, which is what people usually use gold for.

“If something happens – and things do happen – the market drops 20%, gold could go up 25%.

“You’d have to give up the benefit of a powerful hedge.

“This is why this is not really a bet on gold. You’re short volatility. Having a directional view on gold is sort of irrelevant.”

BMO Capital Markets Corp. is the agent.

The notes will price on Oct. 26.

The Cusip number is 06367TM31.

© 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.