Morgan Stanley's buffered PLUS linked to six commodities offer hedge for equities, upside

By Emma Trincal

New York, May 12 - Morgan Stanley's 0% buffered Performance Leveraged Upside Securities due Nov. 29, 2016 linked to a basket of commodities offer an attractive structure for commodities bulls or investors who need to hedge their equity portfolio through asset diversification.

The underlying commodities are West Texas Intermediate light sweet crude oil, RBOB gasoline, copper, palladium, soybeans and cotton.

The payout at maturity will be par of $1,000 plus double any basket gain. Investors will receive par if the basket falls by up to 10% and will lose 1% for each 1% drop beyond 10%.

Good structure

Matthew Bradbard, vice president of managed futures and alternatives at RCM Asset Management, said he likes the structure, although the length of the notes would not fit his short-term trader's profile.

"I do like the buffer and the two-times, no cap. But I would be short some of these, long some of these with my own duration. And we're talking weeks rather than years," he said.

Bradbard said that he expects some of the basket components to trade down or range bound in the short term.

Trading view

"WTI is in a trading range between $85 and $110. It's been in that range for several years now. Now it's at $100. It's in the middle of that range. You can flip a coin. I don't see a lot of uptrend," he said.

"I don't trade palladium, but if I had to, I'm a seller. We're near 6% from the highs seen in the last four years. And we're 43% off the lows. I see palladium going lower."

On the other hand, he said he is bullish on copper.

"I like copper. It's probably going higher. It's near its lowest, so I probably like copper for the next couple of years," he said.

Agriculture and soft commodities, whose prices depend on the weather, are much harder to predict, he said.

"I'm bearish on soybeans though. We broke a trend line last week. Four month ago it was trading at 1,230 [cents]. It broke the trend line at 1,470 [cents]. So we've seen some appreciation in the last four months. It's up 20%. It may change in direction now and then, but with last week's move I can see a lower trend. Maybe I'll be a buyer in a couple of weeks, then a seller. But it's not realistic to have a two-, three-year view on that," he said.

"Same thing with cotton. I may go long and short. I'd take several sides of this trade in the next year and a half. But right now, I'm short those two commodities.

"Anything growing from the ground is very difficult to predict. So the two-and-a-half-year term is really not something that would work for me. The weather is so unpredictable. I can't tell you what the weather will be like in Chicago tomorrow, so forget about making predictions on Brazil."

Bullish play

Greg Feirman, president of Top Gun Financial Planning, said the notes would be a good fit for commodities bulls given the absence of a cap.

"It looks good. It's a bet on economic growth. ... You have oil, gas, copper in there," he said.

"They give you leverage on the upside and one-to-one on the downside with 10% protected.

"I see this as a pretty good proposition. I like it.

"You have the credit risk, but Morgan Stanley is a pretty stable firm.

"I'm moderately bullish on commodities. As long as we get some decent growth and the Fed remains somewhat accommodative, we should do OK.

"So I think this is pretty good if you're bullish.

"Even if the basket only gives you only 5%, 6% or 7%, you're going to double that. As long as it doesn't collapse and that you don't have a crash, it's a pretty good bet."

Hedging stocks

Scott Cramer, president of Cramer & Rauchegger, Inc., said the notes offer an attractive hedge for equity investors.

"This is an interesting basket," he said.

"Commodities are not any more risky just because they are commodities. But it's interesting to use this asset class for diversification purposes.

"The first thing I would do is to look at those six commodities, have one of my analysts check on the correlation to the stock market. For now, I'm going to assume that it's highly uncorrelated to equities. Something like this would be a very good hedge."

The quality of the hedge derives first from the low correlation with stocks, he explained. The other aspect of it is a result of the structure.

"It has two times leverage, no cap, and two and a half years is not a long time. This would make sense to hedge a stock portfolio, which may have been fairly valued or overvalued. It would be a good play for that."

Perhaps an extremely bullish stock investor may not see the use of diversifying away from equities. But Cramer said it is always a good idea to provide some sort of a hedge regardless of the market direction.

"Some people do believe we're on the verge of an even bigger bull market. I'm not saying this is my view, but the reasoning is companies are sitting on a bunch of cash, they are less labor-intensive and more prompt to use technology, [and] as a result they become more innovative. Whether you are that type of bull or not, it's good to be diversified, and this would be a good way to do it.

"There's definitely more upside. You have limited protection on the downside. The only risk is time, and it's a short period of time".

Morgan Stanley & Co. LLC is the agent.

The notes will price May 23 and settle May 29.

The Cusip number is 61762GBP8.

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