Deutsche Bank's twin-win notes linked to Best Buy offer more appeal to bearish investors

By Emma Trincal

New York, May 16 - Deutsche Bank AG, London Branch's 0% contingent absolute return autocallable optimization securities due May 28, 2013 linked to the common stock of Best Buy Co., Inc. shares give investors a chance to make money if the stock goes up or down, but the potential gain is greater on the downside, giving the note a more bearish bias, sources noted.

If the stock closes at or above the initial share price on any quarterly observation date, the notes automatically will be called at par plus an annualized call return of 12.5% to 15.5% that will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

As a result, the maximum return for a bullish investor would be 12.5% to 15.5%.

If the notes are not called and the stock finishes at or above the trigger price - 60% of the initial share price - the payout at maturity will be par plus the absolute value of the stock return. This payout enables investors to yield a 40% profit out of a 40% stock price decline, noted Michael Iver, founder of iVerit Consultancy.

If the final share price is less than the trigger price, investors will be fully exposed to the stock decline.

"It's pretty decent, especially with that cushion of downside protection," an industry source said.

Bearish bias

Iver noted the asymmetry between the potential maximum gain of 12.5% on the upside and the 40% maximum return that could result from a stock decline of the same amount.

So far, bears have profited from Best Buy's stock price. Shares are down 19% this year to date and have lost 41% over the past year.

Investors, Iver said, want the stock to fall as much as possible up to the 40% limit in order to maximize their return. But if the shares collapse, noteholders run the risk of seeing the price hit the 60% trigger. An overly bearish scenario would then eliminate both the downside protection and the absolute value return, according to the prospectus. Losses in that case would be significant and proportionate to the stock decline.

"Since you can make 40% from a bearish scenario and only 12.5% on the bull side, this note is more for the bearish guy. You're not getting any upside really. You're selling the upside," Iver said.

"It makes sense if you don't think the stock will go up by more than 12.5%. You're getting paid to be bearish on the notes," he added.

He explained how.

Options components

"You're selling a call so you don't get the upside. Your return is limited to the call premium. There is no participation in the upside. You're selling an at-the-money call. It gives you a coupon of 12.5% to 15.5%," he said.

"For the 40% downside protection, you're long a buffer. You're buying an at-the-money put and you're selling an out-of-the-money put at 60% of the initial price."

Iver said that the notes are designed for two different types of investors.

"The first one is bearish on the stock but doesn't see the company going into bankruptcy," he said.

"The second type would be someone who already owns the stock but doesn't want to sell it. They don't want to realize the loss. They rely on the put to give them protection on the stock that they own."

To gamble or not to gamble

A sellsider, however, said that products such as this one, alternatively called dual directional, absolute value, twin-win or bull-bear notes, are in his opinion "toxic" in general.

He said that the absolute return and protection features are contingent and would disappear once the barrier option was hit.

"The person buying this note is not expressing any view on the stock. They couldn't care less of the stock going up or down. It's really about selling volatility. To me, if you want to do that, you're better off doing it OTC instead of buying a product with a bunch of fees," this sellsider said.

The product's rationale - making money in both up and down outcomes as long as the share price remains within a range - is the equivalent of a straddle in options, he said, not so much an equity strategy.

"It's very different from a leveraged buffered note for instance where you have an investor expressing a view on the underlying based on some analysis. He can be bullish or moderately bullish. He wants to be long that stock," he said.

"These notes are not comparable. You get a positive return if it goes up a little or down to a point but not down by more than a certain point. To me, it's gambling. I include knock-outs in the same category of misleading products, by the way."

A market participant disagreed.

"Gambling is purely a game of chance. Speculating and investing are based on insight. Those products are not a gamble. They relate to a view. It's a gamble to leave your house every day," he said.

The notes (Cusip: 25154V193) are expected to price Friday and settle May 24.

UBS Financial Services Inc. and Deutsche Bank Securities Inc. are the agents.

The fees are 1.5%.

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