Morgan Stanley's notes tied to Euro Stoxx 50 offer unlimited gains, big buffer but long tenor

By Emma Trincal

New York, June 12 - Morgan Stanley's 0% airbag performance notes due June 30, 2023 linked to the Euro Stoxx 50 index give investors exposure to the euro zone equity market with no cap and a conservative buffer.

But offsetting these benefits are a long holding period, exposure to Morgan Stanley credit risk and no dividends for a long period of time, sources said.

The payout at maturity will be par plus 235% to 250% of any index gain. The exact participation rate will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 50% and will lose 2% for each 1% that it declines beyond 50%, if any.

"I don't like these very long-term deals on stocks," a market participant said.

"A 50% buffer looks attractive, but it's really 5% per annum.

"If you consider the Euro Stoxx index, which has a 3.5% dividend yield, it doesn't seem all that attractive. Ten years is a very, very long investment horizon. I'm actually astonished."

Investors in the notes must forgo dividends paid on the stocks included in the index, which is what the 3.5% dividend yield of the index represents. Over the 10-year period, the lack of dividends generates an opportunity cost, this source noted.

Missing a fat yield

"Multiply 3.5% by 10 ... That's a lot of potential return to be missing," he said.

"I could give 2.5 times leverage for two years with no cap. It will be without any buffer of course. But it would be better."

He noted that the term of the notes as well as the dividend amount payable to shareholders, which the noteholders will not receive, both had an impact on the option prices.

"Each year there is a discount to the expected dividend because of uncertainty. If you go 10 years down, the discount is going to be huge, which means less money available for the options," he said.

"On the other hand, a short-term structure will offer more dividends. Those dividends in turn can be used for the protection or the leverage or both.

"You'd be better off with a two-year note in order to capture the full value of dividends."

Good trade

But a sellsider disagreed.

"It looks like a good investment on the Euro Stoxx for a market that has been beaten up," he said.

The Euro Stoxx 50 has gained only 1.5% this year versus the 13% gain of the S&P 500 index.

"For some people, a 50% protection on the 10-year term may not seem like a lot since it's a long-term note," he said.

"But you have to think, What's the percentage chance this 10-year product is going to lose more than 50% at maturity? I would say the odds of this occurring are less than 1%."

For this sellsider, the structure was appealing for the unlimited upside.

"I don't care about the buffer," he said.

"I think it's a good trade because you have the leverage with no cap.

"Even if you don't get the dividends, you're still likely to outperform the index because of that no-cap piece and because you get 250% upside participation."

UBS Financial Services Inc. and Morgan Stanley & Co. LLC are the underwriters.

The notes will price June 26 and settle June 28.

The Cusip number is 61762E703.

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