Credit Suisse's $15.46 million knock-out notes tied to GM show upside leverage contingency

By Emma Trincal

New York, March 26 - Credit Suisse AG, London Branch's $15.46 million of 0% capped knock-out notes due April 8, 2015 linked to General Motors Co. stock offered an unusual knock-out feature, which triggered or eliminated the occurrence of leverage on the upside in addition to its standard role of conditioning the downside protection, sources said.

A knock-out event occurs if the stock closed down by more than the 10% knock-out buffer amount on any day during the life of the notes, according to a 424B2 filing with the Securities and Exchange Commission.

If a knock-out event did not occur, the payout at maturity will be par plus double any stock gain up to a maximum return of 30%.

Otherwise, investors will receive par plus the stock return with full exposure to losses.

The final share price was the arithmetic average of the five last closing prices.

Not widely seen

"I haven't seen it or this kind of structure. It's unusual," a sellside source said.

"That's interesting. We've been looking at doing a one-off along those lines but nothing within these parameters," another source said.

Not everyone thought the product was unusually structured however.

"I can't say it's a brand new structure in terms of something I already saw or not. We have seen it in the past," a sellsider said.

"Honestly, this is not so unusual. It's a down-and-out call, one of the oldest technologies there is. It's possible that the structure may not have been marketed for a while. But this is not a brand new thing by all means," a structurer said.

Short-term volatility

The sellsider said the structure was timely as it represented a play on short-term volatility.

"Obviously, the interesting feature is the knock-out," he said.

"If the stock at any time loses 10% or more, you lose the leverage on the upside and the protection. What makes it different is that a typical knock-out will make you lose the downside protection and that's it. Here, you also lose the leverage component.

"If volatility is high, the likelihood that you will lose protection and leverage is high. It's a direct play on short-term volatility. Who knows, they may have launched it because of what's happening in Russia and Ukraine. There is short-term uncertainty in the market right now and this is a short term product. Maybe if they had tried to price it a few weeks ago before the crisis, they may only have been able to get 1.6 times leverage instead of 2. I have no idea but I'm guessing that the current market environment, which is definitively uncertain and volatile, encourages these types of products because the spike that short-term vol. brings is giving you better features. And putting together on a one-year a 200% participation rate with a 30% cap is pretty good even if the leverage is contingent."

Pricing

A market participant pointed to the cost for investors.

"If you think about it, a 10% protection on a stock is not much. It's risky although not much more than a reverse convertible and the upside is pretty attractive. Keep in mind though that you, the investor must forgo the dividends and the 3.5% dividend yield that General Motors pays, which is not small. It certainly helps with the pricing," this market participant said.

Down-and-out

The structurer said the structure was simply using leverage with a down-and-out call.

"It's not your standard leveraged product. It's a knock-out on the upside. You have two-times leverage on the upside but once you knock it, by default, it goes back to a one-to-one," the structurer said.

The upside leverage was obtained through the purchase of two calls, he explained.

"The first one gives you the one-to-one exposure. The second one, which brings the two-times, is a down-and-out call that creates the knock-out feature," he said.

"If the stock goes down by more than 10%, the second call gets knock-out and you lose the leverage.

"They also sell a put, which helps buying the two calls. They can also fund it with the dividends and interest payments that investors have to forego. That's how they can put it together. There's enough to buy all this stuff," he said.

The notes (Cusip: 22547QKS4) priced on March 21.

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA were the agents.

The fee was 1%.

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