Structured products agents price $312 million as heavy sell-off rages on; investors seek protection

By Emma Trincal

New York, Dec. 19 – Structured notes issuance was muted in the second week of December amid another stock market sell-off.

Agents priced $372 million in 136 deals, slightly more than the previous week’s $312 million, according to preliminary data compiled by Prospect News. Volume and deal count figures are subject to upward revision.

December is rarely a strong period for structured notes issuance, especially mid-month. But stocks tumbled again, in a decidedly tough month, which during its first two weeks saw the S&P 500 index fall by more than 5%.

The S&P 500 index finished the week down 1.3% as a result of signs pointing to a possible global economic slowdown coming from disappointing data in China and the euro zone. Uncertainties around the upcoming Federal Reserve’s monetary policy decision also weighed on investors’ sentiment. The Dow Jones industrial average finished the week in correction territory while the Nasdaq Composite fell as well.

The year 2018 will be a record year for issuance volume since 2004, according to the data. Last year was the previous record.

Agents in 2018 through Dec. 14 have priced $53.76 billion of structured products, a 9.35% increase from last year’s $49.17 during the same time.

Sales for the full year of 2017 amounted to $52 billion and this year is not yet over.

“It’s been a lot of volatility and it’s been a rough year for the market,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

“I’m personally puzzled by the volume we’ve had this year.

“I guess the more volatility, the better the pricing can get.

“But even though. We’re facing a lot of headwinds and we don’t know if we’re not heading into a recession.”

There are signs of a slowdown in the housing market, in retail and globally, he noted.

“I’m not a bear, I’m not a bull. I’m mixed. But I’m not overly optimistic about for next year,” he said.

Going for cover

The divide between growth and income last week was uneven. While autocallables made for a third of volume, leverage prevailed with a 46% share, the data showed. This trend was a shift from the annual average which saw autocallables being slightly dominant versus participation products.

Since the sell-off began in early October, investors have turned more defensive. Within the leverage category, they have been buying a majority of products with barriers or buffers rather than notes with a one-to-one downside exposure. In fact, more than 85% of all leveraged notes last week came with some form of protection. The average year to date has been less than two-thirds.

“This is in line with what we’ve been doing with our clients,” said Pool.

“We’d rather not leverage up to the upside too much. We really prefer having a little bit more protection on the downside.

“When you show a note in this market, you really have to look ahead and mitigate risk. To think that we’ll have another three, four or five years of growth is to live in a fantasy land.”

Top deals last week were modest in size but all shared the same defensive characteristics – upside digital return if the underlying was above a downside barrier threshold, principal-protection or deep buffer were examples of the tools used to alleviate investors’ concerns.

In-the-money digital

Canadian Imperial Bank of Commerce priced largest deal of the week with $18.92 million of 18-month digital notes linked to the SPDR S&P Oil & Gas Exploration & Production ETF.

If the ETF return is greater than or equal to negative 15%, the payout at maturity will be par plus 19.5%. Otherwise, investors will lose 1.1765% for each 1% that the ETF declines beyond 15%.

CIBC World Markets Corp. is the agent.

“I like this kind of product,” said Pool.

“It’s been really tough in the past couple of weeks, so we’ve been more cautious. We buy the same amount of notes for our clients. But we’re making slightly more conservative choices,” said Pool.

A structurer explained that the note was an attractive defense play for range bound investors.

“It’s an in-the-money digital option,” he said.

He was referring to the initial price on the trade date being higher than the barrier level of 85%, which is the equivalent of the digital option’s strike.

“If the spot is above the 85% strike, you get the digital. It’s not a call option that depends on your net premium or the difference between where the spot is in relation to the strike. Here it’s relatively simple. It’s a binary option. Either you get paid or you don’t.”

The structurer noted that with a 46% implied volatility; the underlying ETF offered good pricing.

“19% is high for an 18-month,” he said.

He also liked the underlying, which provided equity exposure.

“You don’t have issues with contango or backwardation you would have if it was on oil,” he said.

Contango and backwardation are changes in the cost of rolling the oil futures contracts which may impede returns depending on whether the position is long or short.

He also liked the timing.

“This ETF is very much correlated to oil prices, and oil is in a bear market now. With that barrier you still have room to go on the downside while you continue to get paid.

“It sounds like a good idea.”

A shark for your protection

Citigroup sold the second-largest deal, which combines principal-protection and absolute return in a structure that has gained traction in the second half of the year.

Citigroup Global Markets Holdings Inc.’s $15.36 million of two-year absolute return trigger note linked to the S&P 500 index will offer par plus the absolute value of the index if it stays within an upper barrier and a lower barrier during the life of notes. The range between the barriers is plus or minus 24.3% from the initial price. If on any day one of the barriers is breached; the return will be par plus 2%.

Citigroup Global Markets Inc. is the agent.

“It’s a twin-win shark note with a payoff in an “M” shape,” the structurer said.

“If you’re up you get a positive return but if it’s too high, your return drops,” he said in reference to the right side of the “M-type of payoff.”

The structure is very defensive with the full principal guarantee plus a 2% coupon regardless of the market direction, hence the term “twin-win.”

“It would be very hard to create this type of payout without a structured note,” he said.

“You’re long a double-knock-out call and long a double knock-out put.”

The position in other words is the equivalent of being long a call up to a knock-out. The “knock-out” will render the call option worthless when the upper barrier hits. This “leg” of the trade is the equivalent of being long an “up and out” call option, he explained.

The same applied to the long position on the downside except that the call is replaced by a put. That leg of the trade is the same as being long a “down and out” put.

“You need a Monte Carlo to do this. You can’t replicate it with options,” he said.

Regardless of the financial engineering behind the product, those “shark notes” have gained popularity since May when Credit Suisse came out with the first one for the year, according to data compiled by Prospect News.

By far Citigroup has been the most active issuer of such products.

Deep barrier, long life

Another rather defensive product with its long duration and deep barrier was brought to market by Morgan Stanley Finance LLC as the third in size for the week. The bank priced $14.66 million of 10-year trigger gears linked to the Euro Stoxx 50 index. Upside leverage was 4.33 times with no cap. Investors benefited from a 65% barrier on the downside.

UBS Financial Services Inc. acted as the dealer.

Amazon discount

On the income side, one deal of interest was GS Finance Corp.’s $9.83 million of one-year autocallable contingent coupon notes linked to Amazon.com, Inc. Given the strong decline in the company’s share price of late, the note was interesting, sources said.

The annualized contingent coupon is 10.55% payable quarterly based on a 70% coupon barrier. The notes are autocallable if the stock closes above its initial price on a quarterly basis.

The barrier at maturity is 70%.

“I usually don’t like autocalls. But this one isn’t that bad,” said Pool.

“Amazon has been hammered but the company has a very sound business model.

“Also, if I look at the five-year chart, the 30% protection gives me some extra cushion beyond where the support is.”

The top agent was UBS with $80 million in 46 deals, or 21.45% of total volume. It was followed by Goldman Sachs and Morgan Stanley.

The top issuer was GS Finance Corp. with 28 offerings for a total of $67 million, or 18% of the market.

For the year, JPMorgan Chase Financial Co. LLC is the No. 1 issuer with $7.99 billion in 2,105 deals, a 14.86% market share.

© 2015 Prospect News.
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