Morgan Stanley’s $1.19 million autocalls on index, ETF offer easier call, buffered protection

By Emma Trincal

New York, July 5 – Morgan Stanley Finance LLC’s $1.19 million of contingent income buffered autocallable securities due July 3, 2025 linked to the S&P 500 index and the SPDR S&P Biotech ETF offer two less common characteristics for an income product – a call step-down and a buffer at maturity.

Investors will receive a coupon of 5.5%, paid quarterly, if each underlier closes at or above its 75% coupon barrier on the related quarterly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The securities will be called automatically at par if each underlier closes at or above 90% of its initial level on any quarterly call determination date starting Jan. 3, 2024.

At maturity, the payout will be par unless any asset declines by more than its 25% buffer, in which case investors will be exposed to the decline of the worst performing asset beyond the buffer.

The structure is tied to the worst of two underliers, one of which – the ETF – is showing an elevated implied volatility of 39%.

Step-down

“How else do they get the 22% coupon? You need some risk to pick up that kind of coupon, but risk is relative,” said a market participant.

One particularity of the structure was the 90% call threshold versus the commonly used 100%.

“This is part of the risk because they make it easier for you to get called, and if that’s the case, you’re not going to get as much coupon. By moving this call barrier lower, you may stop getting the high coupon too soon, the source said.

Moving parts

Risk is difficult to assess, he said.

“Risk means different things for different people. If you get a lower call threshold, does it add risk or reduce risk? If you want to receive your coupon as long as possible, it’s more risk. But if you try to avoid losing money at maturity, it’s less risk. In theory, if they had made it very difficult to get called, for instance by raising the barrier, then you would get all the risk at maturity.”

Most structured notes get structured following a sequence with adjustments made toward the end, he added.

“You start to price the principal risk at maturity first. You decide if you want to use a barrier, a buffer or nothing. Then you sell the option and apply the premium to the coupon. You can jack up the coupon by playing around with a number of metrics, for instance the barrier level, the size of the buffer, the call strike. You can start adding things. You have to put all the parameters in the model so it’s hard to know what the risk is or why a coupon is so high. It’s just the pricing. There are many moving parts,” he said.

Rolls

The perception of “call risk” varies among advisers.

Some advisers would rather not be called or at least not too early, especially if the coupon is high.

“We’re a small advisory firm. If a note gets called after three or six months, I have to do all that research again and it’s a hassle. Technology has made things a little bit easier, but it’s still very time-consuming to find another deal with similar terms,” said a financial adviser.

A broker said that replacing a called issue presented some benefits in today’s environment.

“If you’re an income investor, rising interest rates can boost your return. As you get called, you’re able to replace the notes at a much higher coupon,” he said.

Buffer

Another interesting feature in the product was the buffer.

“Traditionally people who buy income notes use barriers, not buffers,” said a distributor.

“But it doesn’t have to be that way. When a barrier is breached, you lose a substantial amount of money. Some investors have learned their lesson and they’re now demanding buffers. We’re seeing more buffered autocalls as a result of that. Of course, there is a tradeoff. You’ll have to give up something for the hard protection.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on Friday.

The Cusip number is 61775HCH8.

The fee is 2.75%.

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