Morgan Stanley's dual directional notes tied to gold offer gain potential to some bears, bulls

By Emma Trincal

New York, June 14 - Morgan Stanley's 0% dual directional trigger Performance Leveraged Upside Securities due June 2014 linked to the price of gold are designed for investors who don't anticipate large swings in the future price of the precious metal, sources said.

Investors can capitalize on both rising and declining prices of gold as long as they don't move beyond a range, according to a 424B2 filing with the Securities and Exchange Commission.

If the price of gold finishes above the initial price, the payout at maturity will be par plus 1.5 times the return, up to a maximum return of 23% to 28%. The exact cap will be set at pricing.

If the price of gold falls but finishes at or above the 75% trigger level, the payout will be par plus the absolute value of the return.

Investors will be fully exposed to the decline if the price of gold falls by more than 25%.

Volatility play

Steve Doucette, financial adviser at Proctor Financial, said that investors in the product should be mostly concerned with the volatility of the underlying commodity. While investors may be directionally neutral, they need relatively mild gold price movements in order to maximize their chances of a positive return.

"It's a pretty clear-cut note if you play gold," he said.

"It's got a 12% cap per annum. It's for someone who is still bullish but who remains worried about the downside.

"It wouldn't be for me though. I've never had the gold bug."

Doucette said that the potential gain of up to 25% on a declining value of gold is attractive. But the high volatility of the precious metal makes it hard to assess whether the 25% protection is enough.

"While there's been a correction, the scary thing is that gold has been on such a run, who knows where it will be two years from now," he said.

Doucette assumed an upside cap of 25%, which is in the middle of the 23% to 28% range.

"The 25% cap is reasonable on both ends, up and down," he said.

"Twelve percent return per year over two years: a lot of clients are going to be happy with that. It will sell well, but you really have to have a bullish view on gold. You can't be too bullish, but you can't afford to see a correction of 25% or more, which is always possible with gold."

Straddle

For Brian Kelly, co-founder of global macro hedge fund Shelter Harbor Capital, the product reflects an option strategy that allows the investors to gain regardless of the direction of the reference asset price. This strategy, called a straddle, only works when the price moves within a range.

"Sounds like a complicated way to put a straddle on gold. The issuer has to go through the process of putting it together, they have to hedge it. I suppose it translates into more fees," he said.

"Perhaps it may help institutions that may not be allowed to use options or buy gold. If you run a fixed-income fund for instance, you can buy a two-year bond but you can't buy gold. That type of note would be a solution to this mandate problem.

"I guess it could also be used by a retail investor as an alternative to shorting. With this note, you have a way to express a bearish view.

"The good part is that your whole range of profits, 25% up and down from the initial strike, is a pretty big range to express a view on gold."

Neutral

The notes may be suitable for bullish investors, although they cannot be too bullish due to the cap, Kelly said.

The product could also be appealing to moderately bearish investors who don't foresee a correction in excess of 25% two years from now.

But the notes would be a poor match for investors who are neutral on gold, said Kelly.

"I'm neither bullish nor bearish. I have no position on gold. I'm neutral. I don't see any catalyst one way or the other. So I wouldn't buy this," he said.

Kelly said that he can foresee what would be the triggers for the price of gold to go up and down.

"What would hurt gold would be a strong dollar and falling demand from India," he said.

"What would help would be a globally coordinated money-easing operation. I say globally because I don't expect the Fed to have such an impact by itself at this point. I don't believe they'll do QE3. I believe they'll extend Operation Twist, which is not money-supply expansionary," he added.

But which one of those scenarios would play out remains unclear, he said.

For instance, he noted that a global round of money easing may be good for gold at first. At the same time, such central bank interventions could be accompanied by a bear market if they signaled a worsening of the European credit crisis. Falling stock prices could in turn lead to forced sales of gold as seen in 2007.

Risk versus reward

Others believe that the structure itself is defensive enough, even if gold prices remain volatile.

"I like the risk/return profile on this note. Gold has fallen to much lower prices, and I don't see 25% depreciation from where it is at right now," said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

The price of gold has lost 15% since its peak in August 2011. It is up almost 4% year to date. At the end of February, gold recouped some of its losses from August, but it has lost 8% since then.

"I think the barrier is fair on the downside," Medeiros said.

"On the upside, you have the potential to do 12% a year. A 12% cap relative to the barrier is a good trade-off.

"It might be for an investor looking to add a little bit of risk to their position but apprehensive about taking a large position. You can benefit from the downside up to a point."

The notes will price and settle in June.

Morgan Stanley & Co. LLC is the agent.

The fees are 2.25%.

The Cusip number is 617482N67.

© 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.