Bank of America's leveraged notes linked to Arca Gold Miners offer capped, short-term bull bet

By Emma Trincal

New York, March 18 - For investors who want to get exposure to the recent bull market in the gold miner sector, Bank of America Corp.'s 0% Accelerated Return Notes due May 2015 linked to the NYSE Arca Gold Miners index offer a way to get exposure to the asset class, sources said.

But the notes present some risks both on the upside and on the downside given the volatility of the underlying index, an adviser said.

The payout at maturity will be par plus 300% of any index gain, up to a capped return of 30% to 34%. The exact cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will be exposed to any losses.

For Dean Zayed, chief executive officer at Brookstone Capital Management, the high level of leverage and the short duration make the product attractive.

"It's interesting. I do track the gold miners and even the junior gold miners. This is one of these asset classes that have been so beaten up, so unloved, so out a favor, historically, these are the ones that can have a very rapid pop on the upside, which is happening," he said.

Tactical

The exchange-traded fund that tracks the underlying index for the notes and trades under the ticker "GDX" is up 25% for the year. Last year, the same fund was a in a bear market, down nearly 55%.

"I am actually a bull. I took that position six months ago, maybe too early, but the market is now up, and I'm not surprised about the bounce this year," he said.

"I like the notes. The short term is appealing. The underlying is appealing. You don't have any downside protection, but if you just bought the GDX, you would have full downside exposure as well. And you get a fairly generous cap.

"It's a tactical play. It's a very attractive way to get exposure."

The 30% to 34% cap over 14 months is naturally more valuable for the "not extremely bullish" investor, he said.

"Given the run-up that we've had already, I don't anticipate a huge upside, and that's when the leverage comes into play. If it's up 10%, you get 30%. You really win. I am still bullish and I still see more upside. Do I see 30% upside potential? Maybe not. That's why the leverage is really a big plus," he said.

Cap

Steven Foldes, president and chief executive of Foldes Financial Management LLC, has a different take. He sees the potential for appreciation in this sector greater than the 30% cap. He agrees that the structure offers some attractive terms, however.

"Three times leverage is very nice, especially for a note as short as this one. The 14-month term is great because, one, it's short and, two, it gives you the capital gains treatment," Foldes said.

But an investor in the notes would have to hold a "modest view" on the potential appreciation of the sector, he said.

"If you anticipate a real explosive growth over the next 14 months, you might get capped out, and in this case, you run the risk of missing out on the upside and perhaps missing out a lot.

"The gold miners have been under a lot of pressure, and you now have a significant rebound," he said, pointing to the 25% increase in the index in just the last two and a half months.

"If you look at the upside, first, you can certainly be capped out," he said.

The ETF tracking this index is now pricing at around $26, he noted.

"Over the past five years, we've seen [a] huge rise and fall. This ETF in 2011 was over $60. In 2009, it was at $40. So we are now well below the historic numbers. Going back to the 2009 level of $40 only would require a 53% move on the upside. This note limits your upside to 30%. If you had a big rally, you could easily be capped out," he said.

"Of course, if the index does not grow that much, you benefit from the three times leverage and perhaps you get the 30% cap. It's very nice.

"But you're talking about an extraordinarily volatile asset class."

Highly volatile

The implied volatility of the ETF is 34.5% versus 13% for the S&P 500 index.

"When an underlying is very volatile, investors should be concerned about the downside risk," he said.

"This note does not take care of this. You have full downside exposure.

"If you want to invest in a volatile asset class, I would submit that, first, you need to get some downside protection, which this product doesn't have. And second, you need to make sure that your cap is pretty significant. Neither one of these conditions is met with this structure. There's no downside protection; and on a relative basis, the cap is low given the volatility of the asset class and given the pricing of this fund, which in the last five years, or at least from 2009 to 2013, has traded almost all the time above $40, a price which is more than 50% higher than what it is today."

Redesigning it

Foldes added that he does not like the 2% commission, which is not attractive for a fee-based adviser.

"Apart from the fee, if I wanted to make this note more attractive for us, I would want to get what I believe is needed - the downside protection and a significantly higher level of upside," he said.

"The only way to do both is to extend the maturity of the notes.

"I suppose the term would have to be two years or even three years in order to be able to meet those two requirements. Ultimately, the inclusion of some downside protection and the cap increase would be a function of what the bank would be willing or able to offer.

"But if you give up the short-term maturity and extend the duration, they should be able to do better than just no downside protection and the modest cap.

"So the notes would have to be redesigned around those downside and upside requirements for us to look at it. The price of having a short-term maturity is too high given this particularly volatile underlying index."

The final index value will be average of the closing levels on five trading days shortly before the maturity date.

BofA Merrill Lynch is the agent.

The notes will price in March and settle in April.

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