GS Finance’s $14.16 million bearish autocall absolute return notes on S&P aimed for hedging

By Emma Trincal

New York, May 27 – GS Finance Corp.’s $14.16 million of 0% bearish autocallable absolute return notes due June 23, 2021 linked to the S&P 500 index provide a limited hedge in case of a market sell-off along with full principal protection in a relatively short period of time.

If on any day during the life of the notes the index closes at less than 85% of the initial level, the notes will be automatically called at par, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the index closes at or above its initial level, the payout will be par.

If the notes are not called and the index falls by no more than 15%, the payout will be par plus the absolute value of the index return. If the index declines by more than 15%, investors will receive par.

Simply bearish

Brady Beals, director, sales and product origination at Luma Financial Technologies, said the notes allowed investors to hedge part of their long exposure to the market.

“It’s a pure bear play, some sort of short-term hedge,” he said.

“The market hasn’t recovered fully. It seems reasonable to imagine you could be down 15%, in which case the absolute return gives you some protection on the downside.”

The notes are directional. Investors will not profit from a bull market unlike classic absolute return notes, which allow noteholders to gain from modest price swings both up and down.

“You’re not making anything if the market is up. But it’s fully protected so you’re not losing anything either,” he said.

“With swap rates as low as they are today, getting full principal protection on a one year with a potential return of 15% is attractive.”

Beals said the product also offered the advantage of simplicity.

“You gain from any price decline down to 85%,” he said.

“You bought puts at par and sold puts at 85%. It’s a pure bear spread.”

No rebate

Some similar autocallable bear notes provide for a bonus called “rebate,” which compensates investors when the outcome goes against their view. Instead of getting only their principal back (if the market finishes up or in the case of an automatic call) investors would get an additional 1% or 2% for instance.

“It’s always a tradeoff. Pricing those notes is a function of three factors – the tenor, the existence of a rebate or not, and the absolute return barrier,” said Beals.

“If you had a rebate here, you would have a narrower range of absolute return. The barrier would be closer to the initial value because rebates are expensive. My guess is that it would be around 90%, maybe even 93% or 94%.”

Focusing on the rebate was not necessarily a sound strategy. When buying a note designed to hedge a specific range, the wider the range, the more appealing the structure, he explained.

“You’re not buying those notes for the rebate,” he noted.

“I always lean toward not having a rebate because it’s expensive.

“The higher the size of the rebate, the higher the chances of getting the rebate, which defeats the purpose of the trade.”

Defensive tool

A market participant said the notes should be used as insurance.

A “fair comparison” with those notes would be the purchase of a put option, he said.

“It’s a narrow range. But I can see someone using that as insurance, like a put. They’re on the other side. If the market is bullish, more benefit for them. But if the market is down, they can use the notes as a hedge,” this market participant said.

“You would use it as you would use a put. But at least you still have the opportunity to get your money back at maturity or when it’s called whereas your put could easily expire worthless.”

Not making money if the market is up was not a concern when using the notes for the right purpose.

“You may just get your money back after one year and nothing else. But I wouldn’t see it as an opportunity cost,” he said.

“Every insurance is designed to protect against a risk that may or not materialize.

“This product is an alternative to sitting on the sidelines. At least you can make money if there’s a pullback. It should be used as a means of hedging.”

The notes will be guaranteed by Goldman Sachs Group, Inc.

The underwriter is Goldman Sachs & Co. LLC.

The notes will settle on Friday.

The Cusip is 40057C2Z3.

The fee is 0.48%.

© 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.