Morgan Stanley’s autocalls on Nasdaq, energy ETF allow exposure to high-flyers with less risk

By Emma Trincal

New York, Aug. 9 – Morgan Stanley Finance LLC’s upcoming jump securities with autocallable feature due Aug. 23, 2027 linked to the worst performing of the Nasdaq-100 index and the SPDR S&P Oil & Gas Exploration & Production ETF give investors exposure to high-performing sectors while reducing the risk associated with owning long positions in toppish assets, sources said. The structure also offers a high premium.

The securities will be called automatically starting Aug. 21, 2024 at par plus an annualized call premium of at least 18.55% if each underlier closes at or above the call threshold, 90% of its initial level, on any quarterly determination date, according to an FWP filing with the Securities and Exchange Commission.

The exact call premium will be set at pricing.

At maturity the payout will be par plus at least 74.2% if the worst performing underlier finishes at or above its 90% call threshold.

If the worst performing underlier finishes below the 90% call threshold but at or above its 60% downside threshold level, the payout will be par. Otherwise, investors will be fully exposed to the decline of the worst performing underlier.

Tactical play

“That’s a great note,” said a market participant.

“You take the worst of tech and energy. They’re not correlated assets. You couldn’t structure these terms otherwise. Putting those two together helps pay the higher coupon.”

The strong performance of each underlying was also a way to generate more premium.

“Accepting the lesser return of these two has some risk to it. Tech had such a great run it shouldn’t be shocking if we had a correction. XOP was down a lot back in April and May but had a wild run since.”

“XOP” is the ticker for the underlying energy ETF.

The structure, however, was designed to mitigate the risk of investing in richly valued assets.

“You’re de-risking your position by having the call strike 10% lower than the initial price.

“It’s particularly useful when you’re dealing with high-flyers. You can still continue to participate but at a very low risk level,” he said.

Even if the worst of underperforms for the first year or even 18-months, the tenor offers enough time for a rebound allowing investors to pocket the full premium, he noted.

“The premium is cumulative. If you get it, you hit a homerun. Having the one-year no-call is a very favorable feature.

“It’s a great tactical trade. That’s how you should be using structured notes.”

Dispersion coming down

A buysider also liked the product.

“18.55%...that’s a nice, juicy yield. The 65-basis points fee also is not bad,” he said.

“This is actually to me for folks that are a little more sophisticated because those snowballs are not that easy to understand.”

One source of premium derived from additional risk was the high dispersion between the two underlying.

Dispersion risk is introduced when the correlations between underliers are weak or negative. In an extreme example, two underlying assets moving in opposite directions would strongly increase the odds of breaching the barrier.

The correlation coefficient between the Nasdaq-100 and the SPDR S&P Oil & Gas ETF over a four-year period is 0.5, where one is perfect.

“I like this product a lot despite the high dispersion between the two underlyings,” he said.

He did not expect the metrics to remain that high.

“The dispersion between tech and energy might have reached a peak since March 2020 when it was negative when oil price was negative.

“I think the dispersion between the two asset classes is going to die down over time.”

Such a scenario would mean the two assets may be more likely to move in a similar direction. It would reduce the risk associated with the non-occurrence of a call or a loss of principal at maturity.

Volatility

This buysider downplayed the concerns over the high valuation seen in the energy sector.

“Energy has been the best performer at least in 2021 and last year. But during Covid, it fell off the chart. It was a total collapse. Now the fund is still below the 2014 high,” he said.

The ETF closed at $148.34 on Wednesday, or 56% off its high of $336.16 on June 23, 2014.

With dispersion between the two underliers coming down, the high premium had to be found elsewhere, he said.

“There are not so many places to go to. The volatility of XOP is what brought that 18.55% coupon.”

The implied volatility of the SPDR S&P Oil & Gas Exploration & Production ETF is 32.58% versus 22.47% for the Nasdaq-100 index.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Aug. 18 and settle on Aug. 23.

The Cusip number is 61775HVL8.

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