Barclays’ Accelerated Return Notes on basket of technology stocks seen as highly risky

By Emma Trincal

New York, Sept. 14 – Barclays Bank plc’s 0% Accelerated Return Notes due November 2021 linked to an equally weighted basket consisting of the common stocks of Facebook Inc., Amazon.com, Inc., Apple, Inc., Netflix Inc. and Alphabet, Inc. present a well-structured product but very risky play, advisers said.

The payout at maturity will be par of $10 plus 300% of any basket gain, subject to a maximum return of 27% to 31%. The exact maximum return amount will be set at pricing.

Investors will be exposed to any basket decline.

Richly valued FAANGs

Lance Roberts, chief investment officer at Clarity Financial, was skeptical about the investment and stressed the risk associated with the underlying basket.

The five stocks are commonly known as the “FAANG,” an acronym made of the initials of each basket component except for “Alphabet,” Google’s parent company, which is represented by the letter “G.”

“Those stocks are going up until they don’t,” said Roberts.

“Investors need to realize that these stocks are extremely overvalued.

“I’m getting three times the upside but I’m one-to-one on the downside and my upside is capped.”

Being long the equity was a better alternative.

“I can buy the stocks or QQQ with three times leverage and I won’t have to be capped.”

QQQ is the ticker for the Invesco QQQ Trust Series 1 ETF, which allocates 38% to the five “FAANG” stocks.

The fund has soared by 84% from its low on March 23 to its all-time high on Sept. 2.

“Assuming the FAANG will continue to rally at the same pace, you’re giving up 50% in return,” he said referring to the 30% maximum return.

“The risk I’m taking way outweighs the reward.”

“There is a huge demand for speculation on FAANG stocks.

Buyers and writers

“Before considering a note like that, you have to ask yourself: what is the other side of the trade? Why would they issue that note?”

Retail investors have been pouring into call options contracts on technology stocks this summer. Being long a call option is a bullish bet giving investors a chance to profit if the underlying price goes up above a set price while limiting the risk to the cost of the contract.

News reports last week revealed that Japan's SoftBank Group bought about $50 billion in options linked to technology stocks. About $4 billion were purchased in some of the FAANG stocks, including Amazon, Netflix, and Alphabet, according to SEC filings.

“The volume of call options that are trading right now is higher than in any other time, even during the dot.com bubble,” he said.

The notes mimic the purchase of call options used to leverage up the return of the FAANG stocks.

“In order to buy calls somebody else is writing calls.

“There is another side to this trade...a big institutional investor or hedge fund hedging the risk.”

Roberts did not like the full downside exposure nor the cap. The lack of liquidity was a serious drawback as well.

Illiquidity, timing

“The value of those stocks is overstretched. You’re not going to get that much upside,” he said.

“If I see a 6% gain in the next six months and want to sell at that point, I can’t do that. You can’t really sell. There’s no lock in value.”

The deal came somewhat too late, he added.

“If this had come out in March when the market was deeply depressed, I’d be all over it. All five stocks were oversold.

“But now you’re asking me to buy that note at the top of the market.

“If the timing was right, I would buy it. I do like the structure,” he said.

For Roberts the notes were mainly designed to provide a hedge for the “other side” of the trade.

“Someone is hedging these positions and writing call options, whether it be a hedge fund or institutional investor.

“Someone is looking for dumb money to buy it,” he said.

If anything, the notes illustrated a state of complacency at this stage, he concluded.

“It shows us where we are in this investment cycle. It’s all about greed. There is no fear. No one is talking about a crash,” he said.

Basket of stocks

Scott Cramer, president of Cramer & Rauchegger, was not particularly impressed either.

“At first glance this looks like options on a basket with a cap on the upside and no downside protection,” he said.

“It wouldn’t be my inclination to buy this taking the full downside risk.

“You can play this differently by purchasing the options straight out. It would be liquid, and you would not have a cap.”

An advantage of the notes however was the diversified basket used as the underlying.

“It might not be easy to diversify if you had to buy several option contracts on each stock,” he said.

The simplicity of packaging the options in a note offered some advantages and may even be cost-effective.

The notes carry a 1.75% fee discounted to 1.25% for purchases over $3 million.

“It seems expensive at first. But I’m sure those calls are expensive too,” he said.

“A lot of people are buying options on those names. There’s a lot of implied volatility.

“They have to pass that cost somewhere.”

Risk-reward

Still, Cramer would not buy such a product without any form of downside protection.

Buying call options carries risks but at least investors only risk losing the premium they paid, which is a small fraction of the notional value of their position, he explained.

“With this note, you are long on the downside. You can lose 100% of your investment. I wouldn’t be excited about having a cap because there are other ways to leverage the upside while maintaining some liquidity if things go bad,” he said.

BofA Securities, Inc. is the underwriter.

The notes will price in September and settle in October.

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