Credit Suisse’s 11.55% contingent coupon autocall tied to Nvidia offers alternative to long bet

By Emma Trincal

New York, Feb. 16 – Credit Suisse AG, London Branch’s plan to price contingent coupon autocallable reverse convertible securities due May 22, 2019 linked to Nvidia Corp. stock allows investors to monetize the volatility of the popular stock and change the risk-adjusted profile by giving up some of the upside and reducing the risk compared to an outright investment in the stock, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes will pay a contingent monthly coupon at an annualized rate of 11.55% if the stock closes at or above its 60% coupon barrier on an observation date for that month, according to a 424B2 filing with the Securities and Exchange Commission.

After six months, the notes will be called at par if the stock closes at or above its initial level on a quarterly observation date.

The payout at maturity will be par unless the stock finishes below its initial level and ever closes below the 60% knock-in level during the life of the notes, in which case investors will receive a number of Nvidia shares equal to $1,000 divided by the initial share price or, at the issuer’s option, the cash equivalent.

High-flyer

“This is a high-risk/ high-reward kind of play,” Hampson said.

“You have quite a high coupon at 11.55%, which is due to the high volatility of the stock.”

Nvidia, a technology stock, has an implied volatility of 38%. The company focuses on graphics processing units, used in gaming and artificial intelligence. Over the past year, the share price has surged by more than 125%. So far, the stock, which is a favorite of momentum traders, has been moving upward despite a small retreat in the recent sell-off. As a result, the security is richly valued with a price/earnings ratio of 50.

Barrier

“This is a trade that requires some protection. The issuer here offers an attractive level with a 60% barrier, which is “quite low,” she said.

However, the type of barrier used is adding some element of risk, she noted.

The issuer introduced a so-called “American” barrier, which can be breached on any trading day as opposed to the typical “European” barrier, which is observed at maturity only.

“This is another factor that helps explain the pricing of this high coupon and low barrier,” she said.

Equity substitute

The notes can be used for income. Bullish investors may also benefit from the payout given the potential return.

“The coupon is attractive. It’s more equity-like than fixed income. Of course being long the shares does not limit your gains and you could do much better buying the stock. But there are risks associated with that. Rather than investing in the stock, you may want to use this to benefit from the volatility while reducing some of the risk with the autocall and the barrier,” she said.

Early call

Future Value Consultants generates stress testing reports for structured notes. Each report consists of 29 tables or tests designed to illustrate the probabilities of occurrence of each outcome associated with a particular product and across different market scenarios. Some of the analyzed outcomes for this product are the probabilities of an automatic call at different call dates (named “call points” in the report) as well as probabilities of coupon payments at different payment dates.

Since the notes can be called quarterly after six months, there are four call points and 15 coupon payment dates for the monthly observation over the 15-month note.

“The probability is quite high of getting your coupon, particularly for the first few months. But if you’re not called the risk increases significantly,” she said.

Product specific tests

She illustrated the point looking at one of the tables, called “product specific tests.” It showed a probability of 48% of being called in six months, which is at the first opportunity.

“You’re most likely to be called at point one. Since your coupon barrier is pretty low, you also have a high probability of receiving your six coupons,” she said.

The scenario in which the six coupons get paid, corresponds to a 49% probability, according to the simulation.

The difference between those two probabilities illustrates that the odds of getting paid six months in a row without being called on the first call date are narrow.

Perhaps a more interesting statistics is the sharp decline in probabilities between the first and the second call.

“It’s a big drop. We’re talking about a probability of 48% at point one down to less than 10% at point two,” she said commenting on the table.

“If you don’t call at point two, it means you’ve been below 100. Your chances of calling are going to be less in the future. So, you’re becoming more at risk. As your chances of being called get lower, your risk increases. The autocall reduces your risk.”

Capital performance tests

Another table called “capital performance tests” displays average payoffs and probabilities of outcomes across five different market scenarios.

Future Value Consultants employs five distribution assumption sets in its report. They represent five market environments, which are based on volatility and different growth rate assumptions. Those are bull, bear, less volatile and more volatile. In addition, a neutral scenario is the basis of the simulation in all reports. It reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying.

Losses and barrier type

The average payoff in the event of a loss will range from 63% to 68% depending on the market type, according to the capital performance tests table. That is, average losses can range from 32% to 37%.

Hampson said that the average loss is lower than the contingent protection amount of 40%, which would never be the case with a European barrier.

“While the American barrier is riskier, your losses are lower than an equivalent European barrier. If the European barrier breaches at maturity, by definition, it means you have lost at least 40% of your investment. It can’t be less than that.”

She explained why losses were lower in average with the American barrier.

“It’s very possible to breach at some point and to recover above the 60% loss. You may still be down at maturity but not necessarily down by 40%.

“With an American barrier, you lose less but more of the time.”

The probability of receiving less than principal ranges between 17% in the “less volatile” market scenario to 28% in the “bear” scenario, according to the table.

Alternative to equity

In conclusion, Hampson said the note may have an appeal beyond the simple need for income.

“This note may attract someone familiar with the stock and the sector...someone who is aware that it’s a volatile underlying,” she said.

“This trade is a way to reduce the volatility and your chances for losses if you compare it with owning the stock directly.

“In exchange you have to be willing to give up the potential for wide upswings associated with this name.

“It’s just a different risk-adjusted return.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will settle on Feb. 22.

The Cusip number is 22549JPY0.

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