Goldman’s contingent coupon callable notes tied to two ETFs show relative value bet, call risk

By Emma Trincal

New York, Sept. 21 – GS Finance Corp. plans to price callable contingent coupon notes due Sept. 29, 2019 linked to the least performing of the SPDR S&P Biotech ETF and the SPDR S&P Oil & Gas Exploration & Production ETF, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will pay a contingent quarterly coupon at an annual rate of 10% to 11% if each fund closes at or above its 65% coupon barrier on the review date for that quarter.

The notes are callable at par on any interest payment date from March 2018 to June 2019.

The payout at maturity will be par unless either fund finishes below its 65% trigger level, in which case investors will be fully exposed to any losses of the worse performing fund.

Likely loser

Paul Weisbruch, vice-president of ETFs/options sales and trading at Street One Financial, said that investors were getting paid a double-digit premium for taking the risk of an unlikely event, which is a 35% drop in the price of one of the two ETFs.

He assumed that one fund was likely to drop more than the other, which reduced some of the uncertainty around the worst-of, a type of investment in which the underlying exposure is unknown in advance.

“Between the two, the risk is greater in the biotech fund because it’s overextended,” Weisbruch said.

“This fund is in a roaring bull market. It just hit a new 52-week high this week.”

In contrast, the share price of the SPDR S&P Oil & Gas Exploration & Production fell 70% between the summer of 2014 and February 2016 in correlation with the oil bear market. But things are improving.

“Biotech continues to rally and the energy fund seems to have somehow recovered instead of hitting new lows day after day,” he said.

Energy has become a safer bet because investors have rotated some of their assets into the “beaten-up” asset classes and sectors, such as energy, he said.

The SPDR S&P Oil & Gas Exploration & Production ETF has gained 10% since mid-August, he noted.

“The sector rotation to the underperformers has already started,” he said.

Low probability

Regardless of which of the two ETFs is likely to be the worst-performing asset Weisbruch said he thinks the 65% barrier is relatively strong.

“Your only big risk really is to get called. Obviously if the sectors don’t go down in the foreseeable future they’ll probably call,” he said.

But assuming no call, the risk at maturity is mitigated by the performance of the sectors and the size of the barrier.

“I like it because I don’t see either one dropping 35%,” he said.

“You get 10%. Is that a cap? Yes but does it matter if the goal is to get paid a premium for taking a risk on something that is not very likely to happen...a 35% drop or more. It sounds like a pretty good deal to me.

“It’s a nice premium. You’re betting that neither of these sectors will go down by that much.

“It’s like selling a put.

“The limited upside is OK.

“The sideways market view that goes with it is OK.

“You just don’t want any of those two to collapse. I think it’s a sound bet.”

Problematic call

Matt Medeiros, president and chief executive of the Institute for Wealth Management, held a different view.

As a general rule, he said that he was “not a fan” of worst-of structures due to the challenges they pose in managing risk.

“These are two volatile indices and there are a lot of variables to take into account, including the call, in order to determine what your expectations should be,” Medeiros said.

“The barrier is relatively generous for those two indices. But what I really don’t like is that it’s callable.

“There are just too many moving parts on this for my taste.”

He stressed the difference between an automatic call feature and a call option at the discretion of the issuer, which is the feature used in this product.

“If it’s autocall, at least you know what to expect.

“Perhaps this deal was designed for a specific client in mind,” he said.

The 10% contingent coupon was attractive but the risks too high for investors seeking income, he added.

“People who are looking for yield are also cognizant of volatility. I don’t think this is a yield solution.”

Goldman Sachs Group, Inc. is the guarantor.

Goldman Sachs & Co. LLC is the agent.

The notes will price on Sept. 26.

The Cusip number is 40054LSE5.

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