Credit Suisse’s absolute return notes tied to Euro Stoxx to outperform in a range-bound market

By Emma Trincal

New York, July 30 – Credit Suisse AG, London Branch plans to price 0% absolute return barrier securities due Aug. 3, 2018 linked to the Euro Stoxx 50 index, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or above its initial level, the payout at maturity will be par plus at least 275% of the gain, subject to a maximum return that is expected to be at least 30%.

If the index falls but finishes at or above the 75% knock-in level, the payout will be par plus the absolute value of the index return up to a maximum redemption amount of $1,249.99 per $1,000 principal amount.

Otherwise, investors will be fully exposed to any losses.

Steve Doucette, financial adviser at Proctor Financial, said the notes meet one of his requirements: being able to generate gains with limited exposure to the direction of the underlying price.

Alpha potential

“I kind of like this one,” he said.

“This is a pretty decent note if you believe the market is going to trade range bound in the next three years. If it’s true, you can outperform either side.”

The 30% underlying return cap combined with the three-year tenor optimize the chances of getting a positive return in a down market.

“It’s a pretty good downside barrier because if things go really ugly for the next couple of years, if we get a bear market, we can go down then come back and be above that 25% barrier. The outperformance potential is huge. You can outperform the market by almost 50%,” he said.

Cap, leverage

The upside is slightly less attractive due to the imbalance between the cap and the multiple.

“It’s not as good if you’re a real bull and think the market will be higher than 10% a year. ... [T]he cap is a little bit limiting.

“It’s almost three times. The leverage is so high ... the market only needs to be up 11% three years from now. I would try and give up a little bit of leverage and get the cap higher as much as possible.”

The terms – three-year maturity, 2.75 leverage multiple and 30% cap – bring the maximum annualized return to 9.15% taking compounding into account. In order to achieve that level, the underlying index would only need to increase by 10.91% over the life of the notes, which would only be a 3.50% increase a year, he noted.

“It’s pretty easy to hit the cap. I would look into less leverage and a higher cap.

Valuation

Doucette said he always tries to assess the value of the notes in an early redemption scenario as he does not embrace a buy-and-hold approach to structured products.

“We don’t necessarily own our notes until maturity. We value the security changes every day. We try to constantly assess the risk/return profile. Our clients read their statements. We monitor the notes,” he said.

The high leverage factor, while applied to the upside only, would have a negative impact on the notes’ valuation in an early exit scenario, he said.

“The leverage plays out not just on the upside if you look at it from a valuation standpoint, not from a payout standpoint,” he said.

“If the index heads south, you get levered down too because the valuation of the notes is based on the value of the options and you have to figure out what’s the percentage of leverage that’s factored into the option price. Leverage impacts the value of the option in both directions.

“Say the market is up 10%. You get 2.75 times 10%. That’s great. ... [Y]ou’re in the money. The option is worth more. The closer you get to maturity, the more that leverage is important to you.

“If the market turns the other way, the option is still somewhat levered. The market now turns bearish. You’re out of the money. The option will be worth less, and it’s going to be levered down.

“If you’re just one year from maturity and the market is down, your option may not be worth anything.”

A higher cap and less leverage would benefit the investor in both ways: the upside potential would increase investors’ returns and the lower leverage may not hurt the option value as much on the downside, he explained.

“I like absolute return conceptually. But if the market gets really volatile, it’s not worth anything,” he added.

“If you have a reasonable correction, then it’s fine. But if you are in a secular bear market or a secular bull market, it doesn’t work anymore.”

Point-to-point

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he is comfortable with the underlying theme and the terms.

“I like the Euro Stoxx. I am bullish on Europe even in light of some of the challenges that we’ve had with Greece. I think there are good opportunities there.”

The payout structure is also attractive, he said.

“I like the point-to-point,” he said.

“The three-year lookback on the initial purchase price is advantageous for the security.

“The leverage offers the obvious benefit of enhancing the return up to the cap.

“My preference is always if you take equity risk, you should have equity returns without the cap.

“But in this case, the idea of exchanging the upside cap for a positive return if the portfolio is not down by more than 25% is fair. I think it’s a decent trade-off.”

In terms of downside protection, he sees the barrier level as adequate as well.

“For a three-year, from a risk standpoint, I think 25% with this underlier is reasonable,” he said.

“If the barrier had shorter intervals, if it was observed daily or quarterly rather than point to point, I would be less comfortable because with equity volatility, you can easily have a 25% decline. But on a point-to-point basis, it’s a lot less likely.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price July 31 and settle Aug. 5.

The Cusip number is 22546VJ56.

© 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.