Structured products weekly tally at $559 million as April stock sell-off continues

By Emma Trincal

New York, April 27 – Structured products agents priced $559 million in 168 deals as stocks fell for the third straight week, according to data compiled by Prospect News.

Stock underliers were in favor as volatility and earnings announcements provided better pricing opportunities, sources said.

The S&P 500 500 index dropped 2.8% on the week while the Nasdaq fell 2.5%.

One aggravating factor was the Federal Reserve signaling on Thursday its intent to raise interest rates by 50 basis points. The news led the Dow Jones industrial average to lose 981 points on Friday.

Moreover, higher interest rates and inflation raised concerns over the risk of an economic recession.

“If you ask me what is causing this sell-off, you’re asking the wrong person. I don’t know what’s driving the market right now,” a market participant said.

But the increased volatility seen in the equity market since January and in particular this month was “not necessarily a bad thing” for structured notes issuance, he added.

“Volatility comes and goes. It’s not high and stays high. Some days you have more volatility, others volatility drops. It creates pockets of opportunities for investors,” he said.

“It’s just that that the window of opportunity can be short-lived,” he added.

Stock week

Stock underliers made for more than a third of last week’s issuance volume, higher than the year-to-date average of 20% as quarterly earnings reports rolled in.

It’s not entirely clear whether the earnings season incited investors and advisers to jump into the market in order to strike notes with potential better terms, the way option writers take advantage of volatility spikes to generate higher premium.

Sources were skeptical.

“Structured notes investors are not market timers,” the market participant said.

“I think people buy notes during the earnings season only to the extent that they can get a higher coupon.

“Let’s say you’re comfortable with a particular stock. You’re used to getting 9% out of it and all of a sudden you can get 11% or 12%. That’s going to motivate you to buy.

“What drives the decision is the structure and the general comfort level in the stock.”

Timing on Netflix

Sometimes investors get lucky.

A deal linked to Netflix, Inc. last week offered an example.

On Tuesday after the close, the company released its first-quarter earnings, reporting the loss of 200,000 subscribers.

The next day, the share price dropped 35%, its biggest one-day decline since 2004.

On that down day UBS AG, London Branch priced $125,000 of one-year phoenix autocallables linked to the beaten-up stock paying a 6.19% contingent coupon. As a bonus to the 70% barrier at maturity, investors entered the trade with an additional 35% margin of safety due to the share price decline.

“I would have expected a deal of a much bigger size with such a price drop,” the market participant said.

“This one is almost irrelevant. They did another one on Friday for $3.5 million plus a couple of very tiny ones. I guess they did react to the market but for some reason, it really didn’t gather as much interest as one would expect.”

This raised a question related to timing: if the price of a stock suddenly drops significantly, can investors enter a structured note trade on the same day?

“Even though deals are sold rather than bought, a lot depends on the buyside. The issuers are pretty nimble,” the market participant said.

Noteholders are not traders

Two factors may contribute to slow investment decisions in time-sensitive situations, he said.

“First, we all know that: deals don’t get called. When an opportunity arises, there are no proceeds to invest.

“Second factor: money may be sitting on the sidelines as investors are increasingly worried about the market. Volatility is nice for pricing. But when you reach a certain threshold, people get scared.”

Decisions originate from a subtle balance between conviction and fear.

“Overall, you need a more bullish sentiment, or you need a pullback that’s going to give you compelling enough terms,” he said.

Investors’ propensity to enter trades during the earning seasons depend on their risk profile, a distributor of structured products said.

“Volatility is much higher before the announcements. If you want a deeper barrier or a higher coupon or both, it makes sense to do a note ahead of the announcement not after,” he said.

Risk mitigation

“Some people want more certainty, and they will buy notes after the earnings. It’s all a function of your risk tolerance.”

Higher volatility can be used in a defensive way to reduce the risk of missing a coupon payment or the risk of losing principal at maturity.

“When a stock can drop or pop 20% in just one day, you may want to look for guaranteed coupons or coupons with memory. You may also want deeper barriers,” this distributor said.

Volatility can also help curtail other types of risk.

“I think the market is slowly moving away from worst-of. You’ll see a bigger push toward single stocks and single indices. That’s an important trend,” he said.

Punished sector

Steve Sosnick, Interactive Brokers’ chief strategist, saw last week’s Netflix losses as part of a bigger picture.

“It’s not every day that a popular growth stock loses a third of its value overnight – even if that same stock lost a fifth of its value the last time it released earnings,” he said in a recent note.

“While there is no shortage of elements that are specific to Netflix, I see it as part of a broader theme that has been in place for several months – investors are punishing growth stocks that are no longer meeting their lofty expectations for growth.”

At least 10% of this year’s first-quarter issuance volume has exposure to the Nasdaq-100 index, according to the data, and this does not include all the single names.

If sentiment for the popular growth trade seen as a “bastion of stability” after March 2020 turns more bearish, the negative market implications could be significant, said Sosnick.

“A rush to the exit from a crowded trade could have a profound effect on tech volatility specifically and market volatility overall,” the strategist noted.

“Investors need to hope that their favorite growth stocks keep growing.”

The Nasdaq-100 index is already in a bear market, down 21.5% from its November high.

“Tech stocks are in a challenging environment,” said the distributor.

“With rates rising and valuations where they are, growth stocks, tech stocks are under pressure and will continue to be so for the short term.

“I still think that the long-term outlook is good for those stocks. They’re still the companies of the future. But it’s hard to say what catalyst can push them back.”

Yearly tally

Sales of structured notes dropped 15.7% for the year through April 22 to $24.57 billion from $29.14 billion, according to the data.

The deal count decreased to 5,050 from 8,834, a nearly 43% decline.

While the decline is significant, figures are only preliminary and will be revised upward.

The distributor remained optimistic.

“I think the [structured notes] space is going to be fine even if the environment is likely to become a little bit more challenging,” he said.

“People buy structured notes for the downside protection and to create a stream of income in a neutral and moderately bearish market.

“Since people increasingly need to hedge their portfolio, the use of structured notes remains timely and will continue to attract investors,” he said.

Top deals

The top single-stock deal last week was tied to one of the most heavily traded stocks.

GS Finance Corp. priced $26.98 million of three-year autocalls on Tesla, Inc. paying a contingent quarterly coupon of 18.45% per year based on a 50% coupon barrier with quarterly autocalls and a 50% downside threshold at maturity.

Morgan Stanley Wealth Management is the dealer.

“It’s a nice size for a stock deal, but for Tesla, it’s not unusual. They have become more mainstream,” the distributor said.

Volatility around the name was high due to record profits reported Wednesday evening pushing up the stock price 12% the next day. Volatility was also felt downward. The share price since pricing on April 18 – the trade date for the notes – dropped more than 10% in conjunction with chief executive officer Elon Musk’s buyout of Twitter. Tesla is one of the most actively traded securities both in the stock and option markets.

Citigroup Global Markets Holdings Inc. sold two offerings of single stock autocallables – one for $18.85 million linked to Wells Fargo & Co. and the other for $10 million tied to Charles Schwab Corp.

Citigroup also sold a less common structure on a basket of 10 stocks paying a variable rate based upon the weighted average of the modified underlying returns of each basket component, subject to a 9% cap and a 1% floor. The six year’s $6.66 million issue offers full principal protection at maturity.

The top agent last week was Morgan Stanley with $177 million in 36 deals or 31.6% of the total.

It was followed by UBS and Citigroup.

Citigroup Global Markets Holdings was the No. 1 issuer with $150 million in 27 offerings, or 26.8% of the total.

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