UBS' upcoming trigger autocallables to fit mildly bullish views, provide sophisticated hedge

By Emma Trincal

New York, March 26 - UBS AG, London Branch plans to price three different offerings of 0% trigger autocallable optimization securities due March 31, 2017 with a different underlying for each deal.

The first set of notes will be linked to the SPDR S&P Metals & Mining exchange-traded fund, according to an FWP filing with the Securities and Exchange Commission. The second will be linked to the iShares Russell 2000 index fund and the third to the iShares MSCI Emerging Markets index fund.

Same structure

All three deals have the same maturity date and will price at the same time. They have the same payout characteristics.

A call is triggered with any of the three deals if the underlying's share price closes at or above the initial share price on any quarterly observation date. The first observation date will be the same in all three deals, April 1, 2013.

The differences are the amount of call premium paid if the notes are called and the trigger price for the contingent downside protection at maturity.

The call premium is 10% to 13% per year for the deal linked to the SPDR S&P Metals & Mining ETF, 9.1% to 11.1% per year for the deal linked to the iShares Russell 2000 index fund and 8.5% to 10.5% per year for the notes linked to the iShares MSCI Emerging Markets ETF.

If the notes are not called and the underlying shares finish at or above the trigger price, the payout at maturity will be par. Otherwise, investors will be fully exposed to the share price decline from the initial price.

The amount of protection - determined by the trigger price - varies with the underlying. The trigger price is 45% of the initial price for the notes linked to the SPDR S&P Metals ETF, 55% for the product linked to the iShares Russell 2000 fund and 65% for the emerging markets ETF deal.

No growth required

All three notes are designed for investors who believe that the price of the underlying will remain flat or increase, according to the prospectus.

Carl Kunhardt, wealth adviser at Quest Capital Management, said that he would consider only two out of the three notes.

"There's not a lot of difference between all three, but from my own perspective, I would eliminate the SPDR Metals, even if it's a stock index. It's an exposure to metals, and I don't invest in that at all. To me, it's gambling. Gold for instance is overpriced," he said.

"I use a lot of alternative investments, but if it's a specific asset, I'd want something actively managed.

"However, the two other deals look attractive."

The fact that the notes can get called even if the underlying fund remains flat makes the deals particularly appealing, he said.

"You don't know what the duration is going to be. But I believe that you have the potential to be out fairly quickly. All I have to be is even or better. In all likelihood, I'm out of this in one year, and that's a good point," he said.

Even if investors do not get called on April 1, 2013, chances are they will not remain invested for five years, he said.

"It's a quarterly call. Chances are you're not going to stay in until maturity.

"And if you do, if in five years you're still hanging on, it looks pretty bad. But at least you have a reasonable protection. A 55% protection on the Russell and especially 65% on emerging markets, that's a lot of protection."

Kunhardt said that investors in metals or emerging markets "have to know that they're getting a ride on a roller coaster."

Because the underlying asset classes are so volatile, the downside protection makes those notes more compelling compared to a direct investment in the fund, he said.

For bulls

Kunhardt said that he likes the notes linked to the iShares Russell 2000 fund and the iShares MSCI Emerging Markets fund because he is bullish on those areas.

He said that he is bullish on U.S. stocks because companies are "still sitting on cash and paying dividends."

For emerging markets, he said that the growth prospects of the main "countries that matter" - China but also Brazil and India especially - continue to be much stronger than that of developed countries.

"Since I have a bullish outlook on emerging markets and the U.S. and since you get called even if nothing happens, I am pretty sure of getting called in a year. The premium and the short duration make those notes worth considering," he said.

Still risky

Scott Cramer, president at Cramer & Rauchegger, Inc., said that he views those three notes not just as ways to express a bullish view on the underlyings but also as a hedge against a bearish position.

"If somebody likes the space of the underlying, this is a good way to play it," he said.

"It gives a very good downside protection, and you'll probably get called early, and that's OK."

However, investors have to remember that their entire capital is still at risk.

"If you don't get called, you may have a good downside protection. You can only hope that you're not going to breach the barrier," he said.

Playing defense

A way to mitigate risk may be to use the notes as a hedge.

"I can see a hedge fund using one of those notes as a sophisticated trade, a hedge against a short position," Cramer said.

"Say you're short gold. If your bearish bet turns out to be wrong and if gold actually does go up, this is a good way to protect yourself.

"You'll get your money back plus a premium, which you could use to offset part or all of the losses you incurred on your short position.

"You're getting an option on the upside, and you're hedging on the downside."

For someone betting on a gold price correction, for instance, the use of the note linked to the SPDR S&P Metals and Mining could offer a good defense, he explained.

"You may be right to be bearish, but your timing could be wrong. I am myself bearish on metals, but I'm unsure of the timing. Metals could stay overvalued for a while - that's the problem. If you take a bearish stand and end up being wrong, this note could make up for some of your losses," he said.

The issues will price Wednesday and settle Friday.

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The Cusip number is 9026M0515 for the notes linked to the SPDR S&P Metals & Mining ETF, 9026M0523 for those linked to the iShares Russell 2000 and 9026M0507 for the iShares MSCI Emerging Markets deal.

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