Morgan Stanley's autocallables on platinum, palladium seen as risky given volatility, prices

By Emma Trincal

New York, Jan. 27 - Morgan Stanley's autocallable notes tied to two precious metals may be risky given the volatility of the underlying basket and the current price levels of one of the basket components - palladium, sources said.

Morgan Stanley plans to price 0% autocallable quarterly review notes due Feb. 6, 2012 linked to an equally weighted basket of platinum and palladium, according to an FWP with the Securities and Exchange Commission.

The notes will be automatically called at par plus an annualized premium of at least 16.2% if the basket level is at or above the initial level on April 28, July 28, 2011 or Oct. 28, 2011. The exact call premium will be set at pricing.

If the notes are not called and the final basket level is greater than or equal to the initial level, the payout at maturity will be par plus a fixed amount that is expected to be at least 16.2% and will be set at pricing.

On the downside, investors receive par if the basket falls by up to 10% and will lose 1.111% for every 1% that it declines beyond the buffer.

Volatile basket

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that the downside protection offered by the structure may not be adequate based on the historical volatility of the underlying basket.

"We don't invest in specific commodities. We prefer broad indexes," he said.

"When you look at individual sectors or commodities, you're inherently taking on more risk as you minimize your diversification."

A commodity basket concentrated in two precious metals is more volatile and hence involves more risk than a broad equity index, he added.

"You're getting the same type of buffer as a [note linked to a] diversified equity index. Meanwhile the underlier has historically maintained a higher standard deviation than the S&P 500. I don't think you get enough protection with these notes," he said.

"In addition, I don't like the downside participation once you hit the buffer. If it goes through the buffer, then your downside participation is pretty penalizing."

The downside leverage factor may cause investors to lose their entire principal, the prospectus warned in its first paragraph.

Palladium run

Another risky aspect of the deal is the recent explosion of the price of palladium, Matthew Bradbard, president of commodity brokerage firm MB Wealth, said.

"You would have asked me in 2009, 2010, I would have been remotely interested in it. But palladium is a concern, being up 500% since the beginning of 2009. You're getting in a basket where half of your investment has topped out. I don't think the upside is sustainable," he said.

"A 10% buffer when you just had a move of 500% doesn't make a hell of a lot of sense."

In addition, this broker noted that "palladium doesn't have the liquidity of gold, copper or silver."

Platinum

Bradbard said that he did not follow platinum. However, he said he was concerned about the cap when it comes to this basket component.

"Platinum peaked in March 2008 at $2,300 then collapsed to $760 in the end of 2008 when everything went to hell. Now it's back up at $1,800. To be capped out at 16% doesn't make much sense," he said.

The notes (Cusip: 617482QV9) are expected to price on Friday and settle on Feb. 4.

Morgan Stanley & Co. Inc., J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the agents.

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