HSBC’s $355,000 barrier capped leveraged notes on Nasdaq, Russell aimed at recovery play

By Emma Trincal

New York, July 20 – HSBC USA Inc.’s $355,000 of 0% barrier capped market participation securities due Aug. 21, 2023 tied to the least performing of the Nasdaq-100 index and the Russell 2000 index caught advisers’ attention for the upside potential, but opinions differed about the value of the cap.

If the return of each index is positive, the payout at maturity will be par plus three times the return of the lesser performing index, capped at par plus 31.4%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if either index falls by not more than 15%.

Otherwise, investors will be fully exposed to the lesser performing index’s decline from its initial level.

“This is an interesting note. I like the 3x leverage and the cap,” a financial adviser said.

Whether the 85% barrier was going to be sufficient had to be examined, he noted.

He looked at historical data on the Nasdaq-100 index since 1985 and found that over 13-month rolling periods, a price drop in excess of 15% occurred 9.7% of the time. The Russell 2000 index had a similar frequency for the same price move at 8.9%.

“If I had a less than 5% chance, I would feel more confident. Here we’re close to one out of 10,” he said.

“Maybe the odds are better now since we’re at the end of the pullback. But I wouldn’t make any assumption. Other factors come into play like the risks of a recession and also the worst-of.”

Back testing

Measuring the frequency of losses could only be done one index at a time, he said.

“I can’t really evaluate the probabilities for the worst-of. But I can look at the correlations.”

The two indexes have a coefficient of correlation of 0.8.

“They’re not perfectly correlated. But they’re not likely to move in opposite directions either. Now if we do go through a recession, there is a very realistic possibility that we could be down more than 15% from where we are,” he said.

On the other hand, the upside seemed compelling for the bulls betting on a market rebound after the pullback.

Anytime the market rises from 0% to the 31.4% cap level, noteholders will outperform, he said.

There is a 61.3% frequency associated with this scenario for the Russell 2000 index, he noted.

“That’s a wide range. The cap is high. And the three-time leverage should help a lot,” he said.

“If you only had two times with a 18%-21% cap, you would be cutting off a ton of upside. But here, the potential for gains is really good. The cap is high enough to give you a fair chance of outperforming.”

Not for all

However, given the nearly 10% chance of breaching the barrier on the downside, the note should be shown to a selected group of clients, he said.

“This is not meant to be a defensive strategy. If you prioritize defense, you should look for a bond or for another kind of structured note, either with a longer term or with a buffer.

“I wouldn’t show this product to a conservative investor.

“You need to have a neutral/bullish bias. The correlations are not perfect. The barrier is not perfect. But you will be rewarded in a mediocre market,” he said.

Nasdaq

For those who don’t expect the market to be neutral over the next 13 months, the structure is not a match.

Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, said he was comfortable with the issuer’s credit but not with the payout.

“I don’t like the cap. A 31% cap over 13 months looks nice. But not in this market, not after the pullback we just had,” he said.

When the notes priced on Friday, the Nasdaq closed 26% off its November high and the Russell 2000 was 23.8% off its January peak.

“The Nasdaq is sort of the wild card,” he said.

Correlations would be better if the tech-heavy benchmark was excluded.

“I’d rather have the S&P and the Dow or the Russell and the S&P,” he said.

Some changes

Foldes was concerned about missing some of the potential upside in a robust market rebound.

“As far as the note is concerned, having three times leverage is great. You can’t argue with that. But I don’t love the 31% cap particularly since we’ve already been down close to 30%.

“A 31% cap is not enough if we recover from current levels.

On the trade date, the Nasdaq-100 index closed at 11,983.62. If this underlying was to finish at its November high of 16,764.85, the price would have jumped by nearly 40%.

“I would want my upside uncapped or at a higher cap. Something above 40% would be good. To do that, it would make sense to give up the 3x leverage. I would want to see how much of a higher cap I could get based on reducing the leverage,” he said.

The downside also called for a change.

“Having a 15% protection on a short-term note is very nice. But I would want to get a quote on what a buffer would be if I wanted to put a buffer instead of a barrier. A 7% to 10% buffer would be preferable to this 15% barrier,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes settled on Wednesday.

The Cusip number is 40441XEN6.

The fee is 0%.

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