Merrill, Deutsche plan autocallables linked to Select Sectors; notes leave little room for error, advisor says

By Kenneth Lim

Boston, July 16 - Two new autocallable notes by Merrill Lynch & Co. Inc. and Deutsche Bank AG suggest that some investors are hoping for an inflection point in the markets, an investment advisor said.

Merrill Lynch links to sectors

Merrill Lynch plans to price a series of zero-coupon autocallable notes due July 2011 linked to the worst performer of the Technology Select Sector index, the Health Care Select Sector index and the Consumer Staples Select Sector index.

The notes will be automatically called at increasing premiums if each index closes at or above 85% of its initial level on the first observation date or its initial level on the second or final observation

dates. The redemption amount per $10.00 note will be between $11.10 and $11.40 if the notes are called in July 2009, between $12.20 and $12.80 if called in July 2010 and between $13.30 and $14.20 if called in July 2011.

The actual call premium will be set at pricing.

If the notes are not called, and each of the underlying indexes finishes at or above 85% of its initial level, investors will receive par. If any of the indexes finishes below 85% of its initial level, investors will lose 1.1765% for every 1% decline beyond the threshold.

Outcome linked to U.S. economy

The underlying sector indexes for the Merrill Lynch notes are likely to do better if the U.S. economy is healthy, the advisor said.

"Technology, health care and consumer staples are basically consumer-related sectors," the advisor said. "They do better if consumers are spending more, and spending goes up when the economy is doing well. I've heard some people argue that health care is relatively recession proof, but I don't buy that at all. People will put off trips to the doctor, I'll wait out the cold instead of going to see my doctor."

The product is interesting given the current uncertainty about the economy, the advisor said.

"Certainly there's not a lot of confidence right now," the advisor said. "I think this product takes some of that into account. The call level is at 85% in the first year, so obviously if the indexes aren't doing well, but they're still above the threshold, you still get your 11% to 14%.

"But after that the expectation is that all three sectors must do well, so I would still consider it a bullish product. Your view must be that all three sectors are still relatively healthy, they're not going to do too badly over the next year and even if they do, they'll be fine the year after that."

The advisor said the Merrill Lynch note seemed like a reasonable investment.

"I think if you're confident about those sectors it's not a bad investment," the advisor said. "The only thing is that it's a worst-of, so all it takes is one sector, it doesn't behave like you want it to, you're stuck with a bad investment."

Deutsche links to materials

Deutsche Bank plans to price zero-coupon bearish autocallable optimization securities with contingent protection due Jan. 29, 2010 linked to the Materials Select Sector SPDR fund.

The fund is designed to track the movements of companies that are components of the S&P 500 and produce materials, including chemicals, construction materials, containers and packaging, metals and mining, and paper and forest products.

The securities will be called if the fund's shares close at or below the initial share price on Oct. 27, 2008, Jan. 26, 2009, April 24, 2009, July 28, 2009, Oct. 26, 2009 or Jan. 25, 2010. Investors will receive par of $10 plus an annualized return of 18.5% to 21.5% to the call date. The exact rate will be set at pricing.

If the securities are not called, the payout at maturity will be par unless the fund closes above the trigger price - 140% of the initial share price - during the life of the securities, in which the payout will be par minus the fund gain.

Deutsche note risky

The Deutsche product is a risky short position for investors, the advisor said.

"One of the first things that I look at is what happens on the downside, and for this product it looks like you can go from not losing anything to losing 40% with nothing in the middle," the advisor said. "I guess as an investor you need to be aware of what you stand to lose."

But the advisor said the product could be appealing for investors who think the commodity sector has been pushed too high.

"There are a lot of people who think that commodities are hitting a peak and they're going to come down hard at some point," the advisor said. "If you think that way this product actually looks decent. You're getting about...18.5% to 21.5% if it gets called. Plus you don't lose anything unless the underlying goes up by 40%, although if the barrier is breached you'll be losing quite a bit."

The advisor said the structure of the Deutsche notes, like Merrill's, require confidence in a particular position.

"The risk is that you breach the barrier as long as the underlying closes above 40% at any time, so that takes away some breathing space," the advisor said. "Not as much room for error. Of course as an investor you'd rather not have something like that, but if you take it out they'll take out something from your upside."

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