Tepid structured products volume amid holiday week, last-minute sell-off to end bullish year

By Emma Trincal

New York, Jan. 7 – Agents sold $381 million of structured products in the New Year’s week that ended Friday, a modest yet fair volume for a holiday week as activity has not fully resumed yet, sources said based on data compiled by Prospect News.

Ninety deals hit the market, mostly small in size. Seventy two percent of the deals had a size of less than $5 million. The top tier ranged from $5 million to $22 million only, according to the data.

Dead zone

“I was out on vacation. I suppose last week was pretty dead. Holiday stuff... Nothing much,” said a sellsider.

“On the fixed-income side, last year was not great. Let’s hope 2015 will be a better year.”

The stock market ended the year on a positive note with the S&P 500 index finishing up 11.5%. The week however ended in the red with all markets selling off on Friday. Volatility surged during that time, with the CBOE Volatility index up 23% to nearly 18 from 14.5.

Two-thirds of the structured notes issuance volume last week originated from equity-index notes, a higher-than-average market share, the data showed.

Volatility

“I don’t know if volatility really had an impact here. A lot of the stuff was already marketed,” he said, commenting on the overwhelming index-based issuance.

“But looking forward if the market continues to be volatile we may see more index stuff. Single-stocks did very well last year because vol. wasn’t there. Maybe if volatility picks up, it will be good for longer-dated leveraged buffered stuff. I say longer-dated because rates are still low. You need higher rates and higher vol. to get better pricing. If rates don’t follow, we’ll still have to stretch the maturities. And unfortunately it looks like rates are not going up right now... with the bid on Treasuries, yields are falling again. If that’s the trend, it will be harder than ever to do principal-protected notes.”

The yield on the 10-year Treasury fell below 2% on Tuesday.

An example of a longer-dated deal designed to provide an attractive downside protection on an S&P 500 index-based product was offered by Morgan Stanley’ $11.34 million of 0% trigger jump securities with a six-year tenor and a 60% barrier at maturity. The upside was the uncapped index return with a 35.5% minimum return. It was the fifth deal in size to price last week.

UBS AG, London Branch sold the top deal in a short-term, leveraged buffered note tied to the S&P 500 index with a cap – a 15-month product priced at $21.72 million with 1.2 times leverage; a 13.32% cap and a 10% buffer with a 1.11 leverage factor.

The No. 1 single-stock deal, the 10th overall, was significantly small in size. Brought to market by UBS it was $5.8 million of contingent absolute return autocallable notes tied to Delta Air Lines, Inc.

Indexes, single-stocks

Single-stock issuance surged last year, up by a third compared to 2013. Regardless of volatility moves, the “single-stock exposure trend will continue” this year, a market participant predicted.

“People like to use single-names. It allows them to build tailor-made portfolios. Whether you use stocks in structures designed to provide income or return enhancement, you have a greater likelihood to fulfill your payout goals than if you bought the stock outright.

“You’ll always have a majority of equity index deals because people need to diversify. If we see more turbulence this year, index-related deals may look more attractive, although it depends on what you’re looking for really.”

More volatility could translate into more challenges for the structuring of leveraged deals, he explained.

“When you put together a leveraged buffered note, you do two things: you sell the downside and you buy the upside. When volatility increases, you can get more attractive buffers that’s for sure, but your upside leverage suffers. It’s sort of a wash, although I think it’s slightly more of a disadvantage.

“I don’t think you can predict the relative volume of stocks versus indexes. It’s not either or.

“But as people become more aware of the possibility of stock-picking through structured products, the single-stock trend will continue.”

Oil via stocks

With the dramatic plunge in oil prices, investors continued to buy notes betting on the sector as they benefited from attractive pricing.

However, most energy-related deals were not based on oil futures but instead, on oil stocks or energy exchange-traded funds.

Citigroup Inc. for instance priced the No. 4 deal last week with $14.13 million notes linked to the Energy Select Sector SPDR ETF. The 15-month product, distributed by Morgan Stanley, featured a three-time leverage factor with a cap of 20.75% and full downside exposure.

“Oil has turned into contango, which makes the roll more expensive. That’s probably why you see more of those bets linked to equity,” said the market participant.

A market on contango means that the price of longer-dated futures contracts is higher than the spot. It results in an upward sloping rolling yield curve. The “roll” becomes more expensive because short-term contracts sell at a lower price than the cost of purchasing the longer-dated ones, which represents the additional cost called negative yield.

“The interesting story is who will benefit from the drop in oil prices,” he said.

“Several sectors can benefit. It leads me to think that we’re going to see more ETFs or stock-related transactions as people want to play research-angle or oil-impact angles.”

“The interesting story is who will benefit from the drop in oil prices. Several sectors can benefit. It leads me to think that we’re going to see more ETFs or stock-related transactions as people want to play research-angle or oil-impact angles.” – A market participant

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