Morgan Stanley’ $17.22 million currency notes offer bullish bet on the euro versus the dollar

By Emma Trincal

New York, May 5 – Market participants debated over the risk-reward profile of currency-linked notes enabling investors to express a short-term bullish view on the euro relative to the U.S. dollar.

Morgan Stanley’s $17.22 million of 0% leveraged notes due June 9, 2017 linked to the appreciation of the euro relative to the U.S. dollar offered par plus 137% of the currency return, capped at a payout of $2,370 per $1,000 principal amount, according to a 424B2 filing with the Securities and Exchange Commission.

If the currency return was negative, investors would be fully exposed to the decline.

The notes are tied to the currency return.

The USD/EUR exchange rate, expressed as the number of U.S. dollars needed to buy one euro, will increase if the euro appreciates, which is the desired outcome. That’s because it takes more dollars to purchase one euro.

The initial exchange rate at pricing was 1.15.

Paul Weisbruch, vice-president of exchange-traded funds and options sales at One Financial, expressed caution about the investment theme.

Trend

He first invoked technical factors.

“I wouldn’t be comfortable taking that bet. We’re already four months into a euro rally versus the dollar. The dollar bounces strongly when it hits these intermediate-term lows,” he said.

“It was this low at the end of 2015, in the summer of 2015, in the spring of 2015. But on every occasion, it rallied a lot after that.”

The U.S. dollar has depreciated against the euro for most of this year, he noted.

“Some may think it will continue to depreciate, some that it will bounce. But look. It’s an election year. There are many potential obstacles against the dollar continuing to weaken.”

Macro surprises

Most disturbing in his view was the difficulty to make any short-term macro-economic bet in an environment highly controlled by the central banks across the world.

He gave an example of unexpected results: The European Central has been “aggressively” easing and cutting interest rates. Yet the euro has strengthened against all expectations.

“Central bankers are creating huge distortions. They’re not in control. They talk all the time and you can’t predict anything. There is no such thing as the concept of an efficient market anymore.”

Oil prices a variable

Oil prices were another unpredictable variable capable of pushing the U.S. dollar either way.

“The correlation between oil and the dollar is not that clear.

“Now oil is rallying. It’s off its low. While it has helped the euro at the detriment of the dollar, who knows what’s next?”

The impact of lower oil prices on the U.S. economy has surprised many.

“When oil prices were plunging everyone saw it as a positive. But when you have the energy industry losing thousands of jobs, what good is this? The desired effect is not what happened.”

The timing of the deal, especially as the dollar is hit new lows, may not be opportunistic.

“This trade is a bit risky. It might have been better five months ago before the euro broke out. It has already appreciated a lot.”

Clemens Kownatzki, independent currency and option trader, said there was risk. But he liked the trade because it could be easily hedged.

“For me this note is quite interesting actually,” he said.

“Yes it’s definitely capped. But the upside looks attractive. Getting capped out would be a nice problem to have.

“The structure doesn’t offer any protection on the downside. But I could structure something really cheap helping me stabilize the downside.”

Long put

One possible hedge, he explained, would be to buy an at-the-money put on the euro for a one-year contract at a cost of approximately 4%.

“It’s not cheap but I could cheapen that put by doing a vertical spread,” he said.

In a spread, an investor reduces the cost of buying an option by selling another one.

Another way to reduce the cost of the hedge would be to buy an “out-of-the money” put at a strike of 102, which would cut by half the cost of the premium although the risk would be increased by the difference in the two strikes.

Instead of being protected if the current exchange rate fell below its initial 1.15 level, an investor would only get the protection at the 1.10 level.

Volatility

Kownatzki said that he is more willing to take risk in the FX market than with stocks because the volatility of currencies is much lower, at least for the majors.

“I may not buy an equity note that’s capped with unlimited downside. But in this case it’s very different.

Currencies don’t make huge moves. That’s why I’m not too concerned with the downside. I’m not too worried about the cap either. What’s very good here is the leverage.”

Morgan Stanley & Co. LLC is the agent.

The notes (Cusip: 61760QJQ8) priced on May 2.

The fee was 0.93%.

© 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.