BofA’s $22.49 million Bear Strategic Redemption Securities on S&P seen as hedge, short bet

By Emma Trincal

New York, Oct. 29 – As the S&P 500 index just hit a fresh all-time high, the need for long-only investors to hedge their holdings and the temptation for bears to short the market may be met by a recently priced autocallable bearish note, advisers said.

BofA Finance LLC priced $22.49 million of 0% Bear Strategic Accelerated Redemption Securities due Nov. 6, 2020 linked to the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at a premium of 14% per year if the closing level of the index is less than or equal to its starting value on any of three quarterly observation dates after six months.

If the notes are not called, investors will lose 1% for each 1% gain in the index.

“The market is at all-time highs. It’s a way of hedging your portfolio,” said a financial adviser.

No barrier

He pointed to the lack of protection against a rallying market as investors are exposed to losses when the market goes up.

“Most regular autocalls have a barrier at maturity. They’re bullish or mildly bullish. But if you’re wrong, if the index drops by less than the barrier size, you get your principal back at maturity,” he said.

A similar feature could have been created with an “upside” barrier, he suggested. Any final index increase below the barrier would have provided principal protection. But the feature was not used.

“Here it’s the opposite view. You’re bearish. But if you’re wrong you lose on a one-to-one basis.

“Since there’s no protection, I’m not sure how it’s better than owning a short ETF. You could buy “SH” and benefit more.”

He was referring to the ProShares Short S&P exchange-traded fund, which is listed on the NYSE Arca under the symbol “SH.”

The fund tracks the inverse daily performance of the S&P 500 index. Buying it is to hold a short position on the benchmark.

Mildly bearish

“You’re not better off with the notes if we see a big correction because your return is capped,” he said.

“However, if you expect a modest pullback, the double-digit call premium could easily outperform the ETF.

“It all depends on how bearish you are. If you’re view is moderately bearish, it’s OK.”

Investors long the U.S. market may also want to simply use the notes as a hedging tool.

“It’s not a perfect hedge since you’re capped at 14%. But it’s something.”

Another financial adviser who is bearish said the note was a welcome one.

“It’s rare to see plays on the S&P that are not bullish. This one comes at the right time. It gives investors a chance to play the short side and to get a fixed return,” he said.

Unsustainable bull

This adviser said the S&P 500 index is overvalued.

“This is one of the most expensive markets in history aside from 1929 and 2000 if you look at inflation-adjusted P/E ratios,” he said.

“We also had an economic expansion lasting more than a decade. Granted, economic growth was weak at first. But it’s never lasted so long.”

On Tuesday, the S&P 500 index hit a fresh new all-time high before the close at 3,047.87. The new peak followed a record close on Monday at 3,039.42.

But the Dow Jones industrial average did not follow suit on Monday and slightly dropped on Tuesday.

“The S&P hit new highs. The Dow did not. The Nasdaq did not,” he said.

“That’s what you expect to see when you’re getting ready for a big correction. There’s more and more divergence between those benchmarks. You tend to see those divergences before the market turns in a clear direction whether it’s bottoming or hitting a top.”

Likely call

This adviser was not concerned over the fact that the structure did not provide any protection.

“I don’t think you need a barrier. The chances of getting called are significantly high for two reasons. First, you don’t need a big plunge to pocket your premium. Even if the index is down 1%, you’ll get it. Second, this market is too rich. Just because we’re at all-time highs doesn’t mean we’re not in danger of a bear market... Quite the opposite...”

The product could be used as a complement to a short position or alternatively as a hedge, he noted.

“Your return is limited to 14%. But it doesn’t stop you from selling. You’ll benefit from a small drop, which is the advantage of this product. If you’re short the S&P and it drops less than you expected you’ll still get a decent rate of return. You will outperform your short positions,” he said.

Gearing up for 2020

Given the timing of the notes set to mature three days after the 2020 Presidential Election, the notes could also be used in a tactical way as a hedge, he said.

“If you’re in a long position in U.S. stocks, this will provide some kind of a hedge as we get close to a particularly volatile time,” he said.

Overall, the notes may be used by all kinds of investors, from bulls looking to hedge their holdings to bears seeking alternative or additional ways to short the market.

“It’s a decent product. You’re likely to be called. And the timing is perfect.”

The notes will be guaranteed by Bank of America Corp.

BofA Securities, Inc. is the agent.

The notes (Cusip: 09710C261) priced on Oct. 24 and will settle on Oct. 31.

The fee is 1.25%.

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