GS Finance’s PLUS tied to S&P MidCap 400 to outperform in mildly bullish market

By Emma Trincal

New York, March 28 – GS Finance Corp. plans to price 0% Performance Leveraged Upside Securities due July 5, 2018 linked to the S&P MidCap 400 index, according to an FWP filing with the Securities and Exchange Commission.

The notes will be guaranteed by Goldman Sachs Group, Inc.

If the final index level is greater than the initial index level, the payout at maturity will be par of $10 plus 300% of the index return, subject to a maximum return that is expected to be 13.65%.

If the final index level is less than the initial index level, investors will be fully exposed to the decline.

Kirk Chisholm, wealth manager and principal of Innovative Advisory Group, said that in a moderately bullish market, the notes would probably be a better choice than the index fund because the leverage would boost performance.

Aging bull

“This could be appealing to some people,” he said.

“The market will probably continue to be on a bullish trend. The economic data is showing some strength. However, the health care bill being dropped signals more uncertainty.

“Also this bull market is one of the longest ones in history. One of the risks is that the recent rally was built around expectations of a lot of positive changes. If those changes fail to happen, the market may take a different turn.”

While a correction is always a possibility, some investors may be more likely to anticipate a market trending sideways or only moderately higher.

Dividends

“If the market continues to rise but at a slower pace, this note would be favorable to investors,” he said.

“I don’t know if we’re going to get in a little more than one year. To me it looks like a huge boost, not something very realistic. If your expectations are more muted, you would be better off with the notes because you would strongly outperform.

Noteholders unlike shareholders do not receive the dividends paid by the underlying components of the index. The S&P MidCap 400 index yields 1.25%. The amount of dividends investors must forego during the term of the notes (approximately 1.55%) is not “significant,” he noted.

“On the downside you’re at one-to-one... Same as the index, except for the dividends. But it’s not that significant so you’re not losing much more than being long the index.”

“On the upside however, the leverage can make a huge difference in a slow or flat market.

“If you’re mildly bullish, this makes sense.”

Options

Jonathan Tiemann, founder of Tiemann Investment Advisors, said that there was nothing wrong with the investment theme of the notes. But the structured product was probably not cost-efficient instrument to play that theme.

“Some structured notes are appealing because they’re hard to replicate. This one happens to be relatively easy to replicate with options, although you may not have the exact same durations.”

He analyzed how the notes would look like as a “do-it-yourself” trade.

The three times upside leverage, one-to-one downside exposure and the cap consisted in the following transactions: buying the index alone provided full one-to-one exposure up and down. Second, the purchase of two “at-the-money” call options permitted in addition to the long-only position to gain three-times upside exposure above the initial price of 100. The term at-the-money refers to the price of the underlying when the trade is placed. Finally the sale of three call options at a higher strike of 135.65% would create the cap.

The strike is the price at which an option can be exercised. When selling a call at a particular strike price, the seller gets paid a premium for taking the risk of having to sell the security if its price rises higher than the strike.

With this structure, the investor uses the premium received from the sale of the calls to buy the at-the-money calls as a way to lower his cost.

Easily replicated

“I can pretty much do the same with options.

“I may not have the exact same length... There may not be a 15-month contract... But in the unlikely event that your goal is to exactly replicate the terms of the notes, you can get close enough with the option and it’s going to be cheaper,” he said.

“The option trade would also be perfectly liquid, which is not the case with the note.

“It sounds like a bad deal to me. You can replicate this, possibly cheaper, using options.”

Goldman Sachs & Co. is the underwriter. Morgan Stanley Wealth Management is acting as dealer.

The notes will price on March 31 and settle three business days later.

The Cusip number is 36251V440.

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