Bank of America’s $4.61 million bear Stars tied to Russell 2000 offer autocall play for bears

By Emma Trincal

New York, Nov. 2 – Bank of America Corp. priced $4.61 million of 0% bear Strategic Accelerated Redemption Securities due April 27, 2018 linked to the Russell 2000 index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus 10.75% per year if the index closes at or below the initial level on April 21, 2017, Nov. 3, 2017 or April 20, 2018.

If the notes are not called, investors will lose 1% for every 1% that the index’s final level is greater than its initial level.

Rare direction

“Bear notes are not very popular because it’s hard to get investors with that kind of mindset,” a market participant said.

“If stock prices are down, people are usually going to stay away from the market; they don’t usually try to short the market.

“Of course, if we go through a huge bear market, things may change a bit. But usually people tend to be bullish.”

Premium

The autocallable structure, however, is “attractive” for the right bearish investor, he said.

“If you have a bear market in the next 18 months, you have three opportunities to get called with a decent premium,” he said.

“People who do those autocallables want to get called. Of course you always have the possibility of getting called six months from now, but your annual return would still be the same.”

If the notes are called on the first observation date, investors will receive a 5.375% return for the six-month period. If called on the second observation, they will collect the full 10.75% premium. On the third date, the premium increases to 16.125%.

“You can miss a call and catch up with the payment later,” he said.

Call me, please

The risk for investors is two-fold: they have credit risk exposure, and they may not get called, he said.

“Over 18 months, your credit risk exposure is not that different than six months or a year. Not a big deal for a short-term play like this one,” he said.

The risk of losing money at maturity in a mildly or strongly bullish market is the real concern.

“If you’re wrong and the market is up, you’re going to lose one-to-one for each point of index gain. That’s the real risk. You definitely want to be called,” he noted.

The $4.61 million size, which is “not large,” could perhaps be attributed to a reverse inquiry for a particular investor or group of investors, he said, adding that it was only a guess.

Cultural trend

An industry source agreed that bear notes are rare in general. He found this one particularly risky.

“It’s unusual to see bear notes. You really have to get a client with a negative outlook,” this source said.

“The small size of this deal is a testament to the fact that generally bear notes don’t do as well as bullish products as far as participation is concerned.”

It is not necessarily due to the deal itself or to its structure, he noted. Instead he invoked behavioral factors.

“It’s more cultural. I don’t think people say it’s unpatriotic to be a bear. I just think that when you’re a small investor and you’re bearish, you just take your money out. You don’t gamble against the market,” he said.

“The slightest possibility of betting against a market that’s going up and losing money when everyone else is making money is scary for investors.”

In addition, the structure of the product has some shortcomings, he said, at least in today’s environment.

“You have the elections coming up. No one knows what’s going to happen. You’re exposed to unlimited losses if the market goes up. The market is up 25% in 18 months, you lose 25%. Pretty risky, I think. ...”

BofA Merrill Lynch was the underwriter.

The notes (Cusip: 06054B677) priced on Oct. 27.

The fee was 1.5%.

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