Credit Suisse's notes linked to S&P 500, Russell combine worst-of payout and absolute return

By Emma Trincal

New York, July 24 - Credit Suisse AG, Nassau Branch's 0% absolute return barrier securities due Aug. 21, 2014 linked to the S&P 500 index and the Russell 2000 index are an innovative product that incorporates an absolute value payout into a worst-of structure, sources said.

However, the complexity of the product and some of the drawbacks of having the performance linked to the worst of two indexes may warrant the consideration of alternatives to this investment, the sources added.

"That's new," said Dean Zayed, chief executive officer of Brookstone Capital Management.

"This shows the creativity of some of these manufacturers is increasing.

"Kudos to Credit Suisse. They just need to keep it more simple."

A knock-in event will occur if either underlying index closes at or below its knock-in level, 60% of its initial level, on any day during the life of the notes, according to a 424B2 filing with the Securities and Exchange Commission.

If the final level of the lower-performing index is greater than or equal to its initial level, the payout at maturity will be par plus the return of the lower-performing index, subject to a maximum return of 24% to 26% that will be set at pricing.

If the final level of the lower-performing index is less than its initial level and a knock-in event has not occurred, the payout will be par plus the absolute value of the lower-performing index's return.

If the final level of the lower-performing index is less than its initial level and a knock-in event has occurred, investors will be fully exposed to the decline of the lower-performing index.

Complex

"Wow! It's kind of complex," said Clemens Kownatzki, an independent currency and options trader in Los Angeles.

"It took me some time to digest this! You really need to get a spreadsheet and play with the three or four scenarios, always looking at the lowest return.

"It's a worst of combined with absolute value. The absolute value is nice. But I'm not sure I'm comfortable with the worst of."

For Kownatzki, the eye-catching term in the product was the 60% soft barrier. The use of two underlyings with the worst of the two determining the payout is probably how the issuer was able to finance the deep barrier, he said.

"But when you think about it, what are the odds that we'll lose 40% within two years? It would be another 2008-2009 scenario. While it's possible of course, I find it very improbable. And even if it happens, as a trader, I have tools to hedge that," he said.

Zayed agreed.

"Forty percent is a big barrier. You need another crisis for the market to go down 40%. You need another Lehman Brothers or some kind of very negative event to trigger that," he added.

Both sources liked the absolute return feature, which lets investors profit from a decline at maturity and capitalize on the worst-performing index as long as a knock-in event has not occurred during the term.

But they also pointed to less appealing components of the deal.

For Zayed, the deterring factor was the intricacy of the structure.

"I like the absolute return element. It adds a little bit of spice to it. But it's a 12% cap. For that, I'd rather have a straight buffer," he said.

"The terms are fairly competitive, but the notes would likely be too complex for us.

"Because everybody is stretching for yields, issuers are forced to be creative to package terms that may appeal to investors. But this is a product that's hard to understand.

"I would look at other notes that would give you substantially similar terms in regard to total return but in a more clear-cut product."

Worst of

Kownatzki said that the odds of breaching the barrier were very remote. As a result, he said that getting such a barrier did not warrant the exotic worst-of payout.

"It's just a play on the economy, large caps and small caps. That's a very broad economic spectrum. That's what it captures," he said.

"But I don't like worst of. They're very different from a basket where your return would depend on the average of the two indexes, which of course would reduce the risk considerably.

"Why would I want to have the lower of the performing assets as my payout? From a marketing standpoint, it sounds so wrong.

"So even if the absolute return part is great, it's not worth getting into that type of payout structure just to be able to finance it. To me, it's not a good trade-off.

"I'd rather buy the two index funds and do my own hedges. I could be long the indexes and do covered calls on each. With the premium I get from the out-of-the-money calls, I can either get some income or I could buy a put option.

"That's something you can do if you believe the market will stay in a range. At least, you can generate some income.

"Sure if would be more difficult to replicate the absolute return portion of this deal. I guess it depends on the price you're willing to pay for that feature."

The notes (Cusip: 22546TWT4) are expected to price Aug. 16 and settle Aug. 21.

Credit Suisse Securities (USA) LLC is the agent.

© 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.