GS Finance’s $36.86 million early redeemable notes on S&P is the No. 1 bearish trade this year

By Emma Trincal

New York, April 3 –It’s a bull market but the bears haven’t said their last word. With a $36.86 million deal, GS Finance Corp. recently priced the top bearish note deal in size for the year, according to data compiled by Prospect News.

The 0% bearish barrier early redeemable market-linked notes with daily barrier observation due Nov. 16, 2020 linked to the S&P 500 index offer full principal protection with a minimum return of 1%, according to a 424B2 filing with the Securities and Exchange Commission.

The view is bearish but gains are limited to 1% if on any day the index falls by more than 25%, in which case the notes are redeemed.

If this barrier event does not occur, the payout at maturity will be par plus 1% in two cases: if the benchmark is up or if it drops more than 25%. It’s only when the index falls but above the barrier level that investors get the best outcome, which is par plus the absolute value of the index decline.

Top bear

Sixteen bear notes have priced this year so far totaling $98 million. This latest deal is by far the largest one in size, according to the data.

The second biggest one for $26.55 was issued by UBS AG, London Branch at the end of February. That deal also consisted of bearish barrier early redeemable market-linked notes with daily barrier observation linked to the S&P 500 index.

“It’s a very specific structure. Not particularly interesting,” an industry source said commenting on the GS deal, which priced last week.

“The window of opportunity is too narrow unless someone has a specific view.”

But matching specific market expectations was one of the advantages of structuring notes, he added.

“That’s what they’re for. You can define a risk profile to meet the needs of a customer. It doesn’t mean it works for everyone.”

For a broader market, the embedded view of the notes may disappoint.

“If you put money at the bank you can certainly get 2¼ over 20 months. That’s what the issuer uses to pay the guaranteed 1%. The appeal of the notes is to make money in a bear market and up to 25%.”

But investors are likely to earn a modest return.

“And you take the issuer’s credit risk on top of that,” he said.

Beware the odds

A market participant agreed that the notes were very specific in nature, targeting a particular type of investor.

He also warned that investors should take probabilities with a grain of salt.

“What matters is not the probabilities. It’s your outlook,” he said.

“If you have a certain view, if you’re bearish but not too bearish, if you say: I doubt the market will drop more than 25% and if you don’t want to lose any principal, it’s a very good deal for you. If you’re wrong, you have the principal guaranteed plus 1%.”

The probability of getting 1% cannot be too high otherwise nobody would buy the notes, he explained.

“If you knew that 100% of the time you’ll get 1% in 20 months which is much less than the risk-free rate, you would have to be dumb to buy it,” he said.

But the probabilities of getting the worst return of 1% cannot be too small either otherwise banks would not be making any money pricing it, he noted.

Monetizing an idea

“Each outcome has a probability. But investors should not base their investing decision on probabilities,” he said.

“From a probability perspective you (the investor) will always lose, otherwise the bank wouldn’t create the product. They have to be able to price it and make money on it. No one works for free,” he said.

The tradeoff is that structured notes allow investors to create a product that may perfectly reflect their market view no matter how specific.

“You’re bearish but you’re not totally bearish. You don’t expect the market to be up in two years. You want your money back plus a little something. If you have that view, can you do it yourself? Probably not. How are you going to monetize that view?”

That’s how structured products can prove useful, he said.

“Structured products don’t reflect probabilities because only the market price is based on probabilities. If everybody agrees on the probabilities for this particular bearish view - who is going to allow you to short the market?”

This market participant said he liked the notes.

“It’s a good deal. Personally, I’m glad that we’re seeing more principal-protected deals,” he concluded.

The notes are guaranteed by Goldman Sachs Group, Inc.

UBS Financial Services Inc. and Goldman Sachs & Co. are the agents.

The notes (Cusip: 40056F3J2) priced on March 27.

The fee is 1.65%.

© 2015 Prospect News.
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