Scotia’s $10.12 million bear notes on S&P 500 offer high digital payout, hedging strategy

By Emma Trincal

New York., March 26 – Bank of Nova Scotia’s $10.12 million of 0% bearish jump securities due April 3, 2025 linked inversely to the S&P 500 index provide investors betting against the market a rewarding fixed payout but no protection if the bet turns out to be the wrong one. The outcome suggested the note may be best used as a hedge, a financial adviser said.

The payout at maturity will be par plus 36.75% if the index finishes flat or declines, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will lose 1% for each 1% index gain, with a minimum payout of zero.

Better than shorting

“It’s quite a payoff, isn’t it?” said Jonathan Tiemann, president of Tiemann Investment Advisors.

“If you want to hedge an equity exposure this would be a pretty effective alternative to shorting against the box.”

He cited some of the hedging benefits of the note compared to a “straight short position.”

“When you short, you have financing costs involved. You have to borrow the shares and pay interest on margin.

“Also, with the note there is a cap to what you lose. Even though it’s 100% of your principal, you can’t lose more than that. With a short position, the sky is the limit. Your losses are unlimited,” he said.

Investors buying the notes would have to have “a need to hedge,” he said.

“Not everyone wants to hedge. If you hedge out your exposure, you hedge out your opportunity too.”

Hedging strategy

Tiemann said the note should not be used as a directional bet.

“This note has no protection. If the market is up at maturity, you would be risking a lot. It’s not suitable as a stand-alone play. Again, it has to be a hedge against a long position in your portfolio,” he said.

Tiemann pointed to some situations making the note helpful to investors.

“If you don’t want to sell an existing position for any reason, possibly a tax reason, this would be an effective strategy to protect your gains.

“As long as you are determined to hedge some part of your portfolio, this note is relatively attractive,” he said.

Low chances to win

A trader explained the high payout as a result of the overwhelmingly bullish market sentiment.

“The payout is attractive because in one year there is a very low probability that the S&P will be lower,” he said.

“From a note standpoint, one year is a short term. I get that. It’s short in terms of fixed income. But in the equity world it’s kind of eternity.

“Going back to 2009, there has been very few 12-month periods when the S&P, point to point has finished negative.”

For this trader, a bearish bet on the market at this point in time had limited chances to succeed.

“There’s a reason they can pay you 37% a year. The market is saying the probabilities are so low that it will be down a year from now... that’s how they can price that kind of payout.

“The return in and of itself would make me very cautious,” he said.

Bullish ground

The market has been bullish on hopes that the Federal Reserve will cut rates for some time, he said.

“You can’t really bet against the market when all the central banks in the world led by the Fed are now supportive of lower rates,” he said.

“Anyone can be contrarian and bet against both the market and the Fed. But the probabilities won’t support that view. That’s why you get that juicy payout if you’re a contrarian.”

Pricing reflected the momentum mood of the market, which is markedly bullish, he said.

“I understand that contrarian trades can pay off sometimes. If everybody is looking one way, it’s going to come the other way. But there has to be something out there and I don’t believe we have that something.”

Just as recently as last week, the Federal Reserve spurred a rally by signaling three rate cuts this year, a dovish turn leading the benchmarks to new all-time highs.

Election year

“Let’s not forget we’re in an Election year. Regardless of who wins, [Fed] Chair Powell knows that a market meltdown is a proxy for the economy. He wouldn’t let it happen because it would be bad for his employment outlook,” he said.

“For these reasons, I don’t see anything that could push the S&P lower in the next year.”

And this included brewing tensions and wars in the world, he added.

“The war in Ukraine has been going on for more than two years. The market rallied in the face of that,” he said.

“There’s been a war in Gaza for nearly six months. The market rallied in the face of that.

“There’s a military buildup around Taiwan. The market rallied in the face of that.

“You take all these events together. The market hasn’t reacted negatively to any of those bad news.”

The lack of “downside” protection for noteholders made the note even riskier.

“I usually find some reason to hold a note in the portfolio even for a small position,” he said.

“I can’t find enough bearishness in my outlook to even think of buying this one.

“I wouldn’t touch that.”

Scotia Capital (USA) Inc. is the agent with Morgan Stanley Wealth Management handling distribution.

The notes settled on March 20.

The Cusip number is 06417YP86.

The fee is 2.25%.

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