UBS to offer first bearish note linked to performance of euro versus dollar so far this year

By Emma Trincal

New York, May 22 - UBS AG, Jersey Branch's upcoming 0% contingent buffer enhanced notes due Nov. 30, 2012 linked to the euro spot rate relative to the dollar enable investors to make bearish bets on the euro versus the dollar.

The product is the first one so far this year to offer investors exposure to the EUR/USD currency pair, according to data compiled by Prospect News, despite the rise of euro bears in the overall market since March.

Bearish momentum

Amid the growing uncertainty in Europe and ahead of the Greek elections on June 17, investors shorting the euro have pushed the European currency down nearly 6% from its high in February. The euro closed at 1.2683 on Tuesday, its lowest level since Jan. 13.

Yet the supply of bearish structured notes linked to the euro has not followed. Most currency-linked notes giving exposure to the European currency do it through a basket of North American currencies or through other currencies including emerging market currencies.

The UBS product is the first one offering a direct bearish bet on the euro relative to the dollar, the 2012 data showed.

A currency trader said that it is probably because many other investments offer better tools for this particular trade.

Another factor may be that retail investors shy away from a bet seen as highly speculative given the level of uncertainty around the possible exit of Greece from the euro.

If the currency return is positive - meaning that the dollar appreciates relative to the euro - the payout at maturity will be par plus the currency return, up to a cap of at least 9.1%. The exact maximum return will be set at pricing.

Investors will receive par if the currency return is negative but equal to or greater than the negative 7% barrier amount, according to the filing.

If the currency return is negative and below the barrier level, investors will be fully exposed to losses.

"This is a short-term bet on a bullish dollar. If you have a bearish view on the euro, this is not a terrible note. The six-month duration makes it relatively attractive," said Dean Zayed, chief executive officer at Brookstone Capital Management.

"It's true that I don't see too many notes," he said.

"But I guess if you want to take that bearish bet, you can certainly do it via an ETF."

Wild card

Zayed said that he does not find much to object to about the structure, but he would not be interested in this type of investment theme because he remains too cautious about Europe.

"With so much uncertainty, starting with the Greek elections in June, the market could go through huge swings either way. You could have a huge rally or a Lehman Brothers part two," he said.

"My personal view is that you can find better bets out there, and they're not necessarily related to Europe. The situation in the euro zone is too unpredictable. No one really knows what's coming. I wouldn't want to be on either side of this trade."

Zayed said that rather than trying to guess what the future holds for the euro, he looks at opportunities where he sees value from a technical standpoint.

"I like the gold miners, the price of natural gas, emerging markets. Those offer very attractive valuations. They're strong buys," he said.

Alternatives

Clemens Kownatzki, an independent currency and options trader in Los Angeles, said that he too stays away from shorting the euro even though he is a specialist in currencies. In addition, if he were to put on the trade, he said, he would not use the note to do it.

"There aren't so many currency notes in general and not many on the euro. But maybe there is not much demand because there is a zillion ways to express this opinion," Kownatzki said.

"You can use futures, options, options on futures, options on the spot, all different sorts of forwards and of course the ETFs. You have the FXE, the bullish ETF on the euro that can be easily shorted."

He was referring to the Currency Shares Euro Trust, which is listed on the NYSE Arca under the "FXE" ticker symbol.

"An option will let you decide your time frame. You can do eight days, four months, anything you want. You can design your downside protection; you can find all types of barrier options.

"With this note, you don't have a sensible barrier on the downside. If things go bad in Europe, 7% is easily done. There is no leverage and yet a cap on the upside with an unlimited downside potential. It doesn't sound good to me."

Put buying

Kownatzki said that he is surprised at how well the euro so far has resisted selling pressures.

"I'm staying out of the [short] trade. It has puzzled me for a while. Why isn't the euro not at parity at this point? If the Greek crisis is really so bad, why isn't the euro at 1.10 or 1.15? Although it can still happen, a lot of the bad press, negative sentiment has been priced already. For all these reasons, too many unanswered questions, I stay out of the euro trade," he said.

Kownatzki, however, said that if he decided to take a short view on the euro, he would use options rather than the notes for more protection and a better risk/reward trade-off.

"I would buy an at-the-money put so I would know what my maximum loss is," he said.

He mentioned a 214-day contract on the FXE ETF with a premium of less than 4%.

The implied volatility on this at-the-money put is less than 14%, he said, which makes the cost of the premium cheaper.

"Every drop of money below the notional price of today, you make money. You don't have to wait. Your premium is your drawdown. That's your maximum loss," he said.

In order to limit the cost of buying the put, Kownatzki said that he would probably buy a put as a vertical spread.

A vertical spread is the simultaneous purchase and sale of options on the same underlying and same expiration date but at different strike prices.

"I'd buy the higher put price and sell the lower put price. My net premium would be quite cheaper," he said.

He offered the following example: With the FXE ETF trading at $126.55 a share, he would buy the $126.00 put at a cost of 4% and sell the $121.00 put for 2.5%, reducing his net cost to 1.5% instead of 4%.

"I get an almost unlimited return and a substantial downside protection. And if I want, I can leverage that trade by buying more contracts," he said.

The notes (Cusip: 90261JKA0) are expected to price Friday and settle May 31.

UBS Investment Bank is the underwriter. JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are dealers.

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