HSBC plans bearish Russell 2000 notes; leveraged alternative to direct short, adviser says

By Kenneth Lim

Boston, July 1 - HSBC USA Inc.'s planned bearish notes linked to the Russell 2000 index could be attractive to investors who want to capitalize on a very specific short-term trading idea, an investment adviser said.

HSBC plans to price zero-coupon bearish return optimization securities due Jan. 15, 2010 linked to the Russell 2000. UBS Financial Services Inc. is the agent.

At maturity, investors will receive par plus triple any decline in the index, subject to a maximum total payout of 115% to 119% of the principal. Investors will lose 1% for every 1% increase in the index.

The exact payout cap will be set at pricing.

Immediate play

The short tenor of the HSBC notes suggest that the buyers have in mind a specific trading idea, the adviser said.

"It's a six-month product, so obviously the investor is looking for some quick returns," the adviser said. "It's a very specific trade, not like a calendar product that's offered every month."

Bearish products are also usually short-term investments, the adviser added.

"In general you would expect underlying equity prices to move upwards over the long term," the adviser said. "You won't find five-year bear products."

The product is highly risky with no protection on the downside, but investors in the product may not be too concerned.

"I think whoever buys this is really looking for a kind of quick implementation of a trading idea that they have," the adviser said.

"It's a way to get leverage on a short position. My exposure if the index goes up is the same as taking a short position, but if the index goes down I have leverage up to the cap. So it's for an investor who's already prepared to short the index anyway, and as long as they think the index isn't going to go down by more than 15% to 19%, this could be the better option."

Possible hedge

For the HSBC product, investors should expect the Russell 2000 to be slightly lower at the end of six months, the adviser said.

"You're only participating up to 15% to 19%," the adviser said. "And actually you only need the index to fall by 5% to 6% or so to reach the cap, so that's only a very small movement that you need."

The product could be used as a hedge because of the leverage, the adviser noted. For every dollar that is invested in a one-to-one bullish product linked to the Russell 2000, investors only need to invest a fraction of a dollar in the HSBC notes to get full downside protection up to the cap, while giving up a third of the participation on the upside.

The market could have many investors who can use a hedge like this, the adviser remarked.

"I think there was a lot of bullishness over the past few weeks," the adviser said. "Maybe someone who bought something bullish two weeks ago is now thinking that having a bit more protection is prudent and this is something that can be used for that purpose."

But the product's ability to hedge is limited by the return cap, the adviser said.

"This is a bit like a buffer," the adviser said. "If the Russell 2000 goes down by 20% and the cap is 19%, you're don't have protection for that 1% beyond the cap."

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