Morgan Stanley's lookback entry PLUS tied to S&P 500 aimed at calming fiscal cliff fears

By Emma Trincal

New York, Dec. 10 - Morgan Stanley's 0% lookback entry Performance Leveraged Upside Securities due December 2014 linked to the S&P 500 index may be targeting bulls who are anxious about the fiscal cliff negotiations and the potential for a sell-off in January if no deal is reached, sources said.

The initial index level will be the lowest closing level of the index during the month from pricing in December to January 2013, according to a 424B2 filing with the Securities and Exchange Commission.

The minimum lookback value will be 85% of the index closing level at pricing.

The payout at maturity will be par of $10.00 plus 150% of any index gain, up to a maximum return of 23.5% to 26.5%. The exact cap will be set at pricing.

Investors will be fully exposed to any losses.

Hedging the cliff

"That's for a client who believes the market will be up in two years but who's worried about the immediate risk around the fiscal cliff. They're pricing somebody's fear of the political risk in January," said Scott Cramer, president of Cramer & Rauchegger, Inc.

"It's probably designed for investors who need to put money to work now and who believe that the market will go up but are afraid of the impending political gridlock in Washington and a possible absence of a fiscal deal," a sellsider said.

According to the prospectus, the initial value will not be known until the end of the initial observation period, which is January. The notes are expected to price in December.

Lookback

A sellsider explained the lookback.

"If your S&P level is at 1,000 at pricing and your lowest closing price in January is 700, your entry point will be 850. If it's down to 890, you'll start at 890," he said.

That is because the issuer introduced a new feature to the traditional lookback with the 85% limit, he said. The lookback cannot be less than 85% of the index closing value on the pricing date, according to the prospectus.

"You don't have downside protection, but there's a low risk entry level," the sellsider said. "It's not bad.

"Obviously, I like the original lookback structure better than this one because here you have this 15% limit.

"But it's still a mechanism that can reduce short-term risk.

"I've seen lookbacks but not like this one. My guess is that they introduced the 85% limit to make it work from a pricing standpoint."

"They may limit the optimal entry point, but it's still decent and it still gives you some protection, especially with the fiscal cliff perspective," the sellsider said.

Timing the risk

Tax and fiscal uncertainties are not motivating people to invest in general. But things are worse now in today's context of a fiscal gridlock in Washington, sources said.

"It's for people who have money on the table today and want to invest it now but are afraid of the looming fiscal crisis. It's attractive for somebody who's thinking short term but also long term, someone who thinks the market will be marginally up over two years and who can make good use of leverage," Cramer said.

If investors are right in their bet that the market could sell off short term and rise over the next two years, the note would be the place to go, the sellsider said.

"A note like that makes sense if the short-term risk is your main concern but your outlook remains bullish. If the market goes up, you do well; if it goes down short-term, you do well too. You benefit in both scenarios," he said.

Interesting times

As a financial adviser, Cramer said that the lookback, despite its appeal, was not a substitute for a traditional buffer or barrier.

"For me, it's not that exciting because of the lack of any downside protection," he said.

"I can accomplish a lot of things this trade is going to do without being locked in."

"What I find interesting is how resourceful firms are when faced with the pricing obstacles they have to deal with. Option costs are up and interest rates are low. And yet, they'll give you the lowest entry point over a month and the leverage up to a cap trying to make up for the lack of downside protection.

"We've seen an evolution from full principal protection to buffers and from buffers to barriers.

"They're still pushing products and packaging features that make a product look good.

"I find it interesting."

Morgan Stanley & Co. LLC is the underwriter with Morgan Stanley Smith Barney LLC as dealer.

The notes will price and settle in December.

The Cusip number is 61761M136.

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