HSBC’s $500,000 buffered digital notes on three tech stocks provide potential alpha, hedge

By Emma Trincal

New York, April 15 – HSBC USA Inc.’s $500,000 of 0% buffered digital notes due May 16, 2022 linked to the least performing of the common stocks of Apple Inc., Amazon.com, Inc. and Netflix Inc. are designed for investors who rule out wide price moves from the popular technology stocks, advisers said. If volatility is contained, investors could outperform the stocks by up to 30 percentage point. Additionally, they could elect to use the note as a hedge.

However, the volatility of all three underlying stocks poses a risk for this range bound trade, they said.

If the final level of the least performing stock is greater than or equal to 80% of its initial level, the payout at maturity will be par plus 10%. Otherwise, investors will lose 1% for every 1% that the index declines beyond 20%, according to a 424B2 filing with the Securities and Exchange Commission.

More bearish

Steve Doucette, financial adviser at Proctor Financial, said the notes allowed investors to outperform but only if the underlying stocks do not move sharply in either direction.

“You really have to believe it’s going to be down a little bit in the next 13 months or pretty flat, at least not up more than 10%, which isn’t a lot for those high-flyers. That’s the only way you can really outperform,” he said.

“You have a range between minus 20% and plus 10% to beat the return. That’s the only space. It’s actually a large range to outperform but only if you’re not too bullish.”

“The note is more bearish than bullish since your cap is at 10% while you can go down as much as 20%. It’s a decent amount of protection if those stocks do go down.”

Some risks

But some factors added some risk.

“The scary part is it’s a worst-of,” he said.

“You’re also capping your upside. You could miss a great deal of upside.”

Issuers offer hedges in several ways, he noted. Absolute returns are one option, in which the return is the one-to-one inverse participation. With this digital set “in the money” the return is “boosted” to a fixed payout regardless of the amount of decline provided that it’s in the range.

“I do like these boosters. It’s a nice payout. In some cases, it’s better than an absolute return,” he said.

For instance, he explained, a 3% price decline would provide with this note a 10% positive. The gain with an absolute return payout however would only be 3%.

“You outperform best if the stock doesn’t move much. It’s a bit of a challenge with volatile assets.”

Doucette seemed as much, if not more concerned about the upside risk than the downside exposure simply because the buffer guarantees that the note will outperform the underlying.

Three horsemen

“It’s an interesting note if you’re not worried about the stock going through the roof over the next 13 months,” he said.

One way to employ the buffer would be to use it as a hedge in a portfolio.

“If you have a long holding position in these stocks, you could certainly take advantage of this great buffer to play the notes as a hedge.”

In conclusion however, this adviser said he would not consider the product.

I just wouldn’t play this because we don’t do individual stocks. And these are three of the five FAANG stocks, three of the four horsemen. A little bit too volatile for us,” he said.

FAANG is an acronym that stands for five high-performing U.S. tech giant companies: Facebook, Inc., Amazon, Apple, Netflix and Alphabet Inc.’s Google.

Too pricey

Matt Chancey, financial adviser at Dempsey Lord Smith, pointed to the high valuations of the underlying stocks.

“I have more downside risk than I have upside with what feels like overpriced, overbought stocks,” he said.

“These assets experienced a massive growth. A 20% pullback is not only possible, it also feels like normal.

“I’ve seen better trades.”

Apple’s share price has surged 88% in the past year while Alphabet returned 82%. Facebook and Amazon gained 75% and 40%, respectively, during that time.

Netflix was the last in the pack seeing its share price rising 25% from a year ago.

Term

The 13-month duration was not best for this adviser.

“It’s a little short. We typically do 24- to 36-month deals. You get better pricing on longer terms,” he said.

“This investment could work out for somebody. But most of our clients prefer the income version of this note.

“We just put out a note today. Nine percent, monthly income, 60% barrier, autocall on a diversified index.”

Overall, the note failed to provide enough range both on the upside and downside.

“If the stocks move up 50%, you give up a ton of the upside. Such moves are real with these tech companies.

“If it’s down the same amount, your 20% buffer is not giving you enough protection.

“I don’t want to wrap a buffer around these stocks. They’re too volatile. You need unlimited upside when you buy Apple, Amazon or Netflix,” he said.

HSBC Securities (USA) Inc. is the underwriter.

The notes priced on Monday and settled on Thursday.

The Cusip number is 40438C5C1.

The fee is 0.6%.

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