Bank of America's bear notes on S&P 500 TR offer better tracking than funds but added risks

By Emma Trincal

New York, June 4 - Bank of America Corp.'s 0% leveraged bear notes with early redemption trigger linked to the S&P 500 Total Return index enable bearish investors to take leveraged bets on the equity benchmark, but the benefits of the notes versus an equivalent exchange-traded fund are debatable, sources said.

The notes are expected to mature in July 2014, according to an FWP filing with the Securities and Exchange Commission.

The notes are putable at any time, subject to a minimum redemption amount of 5,000 notes, and will be automatically called if the index closes at or above 120% of its initial level.

The payout at maturity or upon redemption for each $10.00 note will be $9.90 plus the product of (a) $9.90 times (b) 300% of the quotient of (i) the initial level minus the final level divided by (ii) the initial level.

Because the payout is based on $9.90 per note, investors will lose 1% even if the index finishes flat. If the index finishes below its initial level, investors will receive three times upside exposure to the decrease; if the index finishes above its initial level, investors will lose three times the index gain.

Bearish view

Donald McCoy, financial adviser at Planners Financial Services, said that he could understand the underlying bearish theme of the notes.

"I can see why some people would be ready to bet against the market. The question of course is timing. We've had a very strong run, and people are wondering when the shoe is going to drop. Everyone is kind of nervous right now," he said.

The underlying index reflects changes not only in the price of the component stocks but also changes in the reinvestment of their dividends, according to the prospectus.

"Using this index adds to your risk in a weird way. The S&P Total Return index is going to give you more return than the price index. So your downside is increased by the yield of the S&P 500. It's a good thing that you can redeem it on any day," he said.

McCoy said that while a bearish bet on the market may make sense for some investors, he would probably avoid using leverage to express such view.

No bonus

"I tend to shy away from leverage in general just because you get super high volatility levels whether you do it with a fund or a note. No matter how you slice it, it's going to be a big concern. I wouldn't see the point of investing in a structured note that gives you three times leverage up and down unless I would get some kind of structural advantage, which I don't get here. You don't have any downside protection," he said.

"On top of that, you're paying 1% for the right to buy the product. You're probably able to get the same leveraged exposure with a fund at a lower cost.

"Honestly, the only thing I like about it is that you can get out of it quickly. But unlike an ETF, you don't even have the daily liquidity. I don't see the upside in using [this] structured note versus using an ETF. If you had the leverage only on the upside and not on the downside, that would make a difference. But that's not even the case. In addition, you're also subject to credit risk. I could get a better deal with a low expense ratio, two or three times whatever index I want and get not even the daily but the intraday liquidity."

The automatic redemption when the index goes up by more than 20% is not really a protective feature, McCoy said, because the trigger event and the actual redemption may not occur on the same day, as stated in the prospectus.

"Three times 20% and a 60% maximum loss ... Isn't it wonderful? It's not even clear that 60% is going to be your cap. It could be 55% or 65%. You don't know," he said.

The prospectus confirmed that investors should not consider the automatic redemption due to a trigger event to be a "stop loss" limit, as "it will not necessarily protect you from losses beyond the 20% increase of the index."

Tracking

Jim Delaney, portfolio manager at Market Strategies Management, said that the notes may offer an advantage over an equivalent fund when it comes to leveraged exposure.

"Say you own an inverse ETF on the S&P with three times leverage, for instance the ProShares UltraPro Short S&P ETF [and] you bought it when the S&P was at 1,000 just as an example. A year later, it's at 900. Your ETF should give you 300 in return. But it's not going to happen because they give you leverage through options and options have time decay on it," he said.

"All these leveraged ETFs are very focused on day-traders. You can hold it for as long as you want, but you may experience significant tracking errors.

"In a note, it's structured in a way that you get the three times whatever. They have to give you the three times no matter what and they manage the risk associated with the options' decay.

"So if you're bearish, you may prefer to buy this issue. Yes, you do get the credit risk and you have less liquidity. But on the other hand, the leverage will be as stated. It's a note, in other words a debenture. It's a legal document. They owe it to you. The risk is on them.

"With a fund, even if the holding period is only a couple of months, they're not going to give you the advertised leverage because of time decay.

"The ETF is intraday, but you have the decay on your return.

"Here you get the three times, but you only have a twenty-four hour liquidity.

"The choice is yours."

The notes are expected to price in June and settle in July.

BofA Merrill Lynch is the agent.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.