Bank of Montreal’s 0% absolute return notes tied to iShares China may offer timely bull play

By Emma Trincal

New York, Nov. 4 – Bank of Montreal’s 0% contingent risk absolute return notes due Nov. 29, 2019 linked to the iShares China Large-Cap exchange-traded fund offer bulls an opportunity to monetize China’s recent push toward more monetary easing, which investors expect will prop up Chinese stocks, an industry source said.

The payout at maturity will be par plus 100% of any fund gain, according to an FWP filed with the Securities and Exchange Commission.

If the fund’s final share price is less than or equal to the initial share price but greater than or equal to the barrier level, 75% of the initial value, the payout will be par plus the absolute value of the return, up to the maximum downside redemption amount of $1,250 per $1,000 principal amount.

Otherwise, investors will be fully exposed to any losses.

Easy does it

“China just cut its rates again, and many are turning quickly bullish. They’re betting that the government is determined to continue easing. And that’s good for stocks,” this source said.

“This is not a bad trade at all. No cap ... absolute return down to 25%. That’s pretty good. You just have to commit to a four-year investment. But it’s China. Nobody wants to make an 18-month bet on China right now.”

Knocking out

A market participant was interested in the pricing, arguing that the terms are attractive.

“You’re long the upside, and the dividend is 1.26%. A four-year [term] gets you 5% as the issuer. But you get absolute return on the downside up to 25% in decline. That looks pretty interesting,” he said.

“To get the absolute return, you buy two puts, but they are knock-out puts at a 75% strike. These are barrier puts.

“If the index is down 10%, normally you lose 10%. But in this case since you’ve got two puts, not only you lose nothing, you also make 10%.

“These two are knocking out at 75%. Once you’re down 25%, you don’t get the loss mitigation anymore and you lose the absolute gain.”

Dividends, spreads

It’s by using the 5% worth of unpaid dividends that the issuer was able to structure the product.

“I’m just wondering if that was enough to buy the two puts. The pricing is interesting,” he said.

“To be fair, the issuer has a little bit more than 5% to play with. If you consider the credit spread, you have a little bit more. But you also have to buy the underlying to structure this. Not only have they had to buy two puts, they also have to buy a call and sell a put to be long the index.

“It’s a pretty interesting deal.

“Compared to buying the FXI now you have a two-way play. The only thing you’re giving up is the dividend and the credit spread.”

The symbol “FXI” designates the iShares China Large-Cap ETF, which is listed on the NYSE Arca.

BMO Capital Markets Corp. is the agent.

The notes will price on Nov. 24 and settle on Nov. 30.

The Cusip number is 06366R4E2.

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