Goldman Sachs' digital notes tied to Euro Stoxx 50 target investors with range bound view

By Emma Trincal

New York, Dec. 18 - Goldman Sachs Group, Inc.'s 0% buffered digital notes linked to the Euro Stoxx 50 index are designed for investors who expect the market to move sideways after nearly five years of a solid bull run, sources said.

The tenor of the notes is expected to be 24 to 27 months, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is greater than or equal to zero, the payout at maturity will be a digital payment, which is expected to be between 16% and 18.5% and will be set at pricing.

If the index return is negative but not below negative 10%, the payout will be par.

If the index return is less than negative 10%, investors will lose 1.1111% for every 1% that the index declines beyond 10%.

Single-digits

"I don't think it's bad," said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

"Yes, your digital payout caps your upside. But at the same time, you only need the index to be up 1% to get 16%.

"Can we really expect another two years from now to be up well above 16%? History seems to indicate that we're not going to get double-digit returns. We're more likely to get single-digit returns.

"You get some return enhancement with the digital. You also have downside protection with the 10% buffer. If the index was down 20%, you would lose about 11%, a little bit more than a regular buffer but not much more. It's certainly better than having no protection or having a barrier of the same amount.

"Pimco recently made a strong statement that the markets are inflated due to easy money. If you're not overly bullish, this deal doesn't seem like a bad one," he said.

Short a strangle

For investors who had been anticipating a correction a year ago and too soon, the odds of a market downturn are becoming greater as we are entering into the New Year, said Jim Delaney, head trader at Market Strategies Management.

"Last year in December people were expecting correction, and this year the market is up 27%," he said.

"Some just thought the bull run would slow down and that we would get around 10%.This year has a better chance to be in that 10% range.

"If you're conservative and you believe that we're going to get two years of pretty low single-digits, then you want this.

"If you look at this structure, it's almost like writing a strangle. You make the most money if the market is not down by more than 10% and not up by more than 18%.

"If you translate that into options, you're selling a put and a call at two different strikes. Your put strike is at 90 on the downside and your call strike at 118 on the upside, assuming that 100 is the at-the-money level. If it goes below 10 and above 18, you get hurt," he said.

In options terminology, writing a strangle consists of selling a call and selling a put with the same expiration date but different strike prices.

The strategy benefits investors when market moves are limited in either direction.

"Selling a strangle on the Euro Stoxx would be a much purer way to express that view than using the notes," said a derivatives market participant.

"The notes business is designed to give investors a number of benefits, but you pay for it. There are mark-ups, fees.

"Conceptually, it might be similar to writing a strangle in terms of options. It might be what the desk is doing to hedge it. But there are more efficient ways to achieve the same thing," he said.

Sources said that current market conditions have made the pricing of buffers challenging. In some cases, issuers have had to extend durations. In others, buffers have been replaced by barriers. Lowering the cap is one more way to do it, they said.

"With less volatility, selling options to harvest the premium is going to give you less to play with," the market participant said.

Goldman Sachs & Co. is the underwriter.

The fees were not disclosed in the prospectus.

The notes will price and settle in December.

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