UBS, HSBC tap into single-stock volatility to provide higher coupons, deeper barriers

By Emma Trincal

New York, Sept. 1 – Structured products issuers are increasingly using single-stock underliers to boost returns. But volatility sometimes needs to be stretched to generate compelling coupons, making the choice of the underlying stock a crucial piece of the structure.

Whether using names perceived as risky, such as recovery stocks beaten up with the spread of the Delta variant, or through the opportunities offered by earnings season, issuers have recently priced notes offering notable yields and/or deep barriers.

Royal Caribbean

One example is UBS AG, London Branch’s $100,000 of 0% trigger autocallable optimization securities due Aug. 31, 2022 linked to the common stock of Royal Caribbean Cruises Ltd.

The notes will be called at par plus a call return of 17.15% per year if Royal Caribbean’s shares close at or above the initial share price on any observation date, which occurs every quarter, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and Royal Caribbean’s shares finish at or above the trigger price, 60% of the initial share price, the payout at maturity will be par. Otherwise, investors will be exposed to the share price decline from the initial price.

“As the market is at all-time highs, volatility is down and rates have also come down...You’re getting in a situation where there are fewer notes and sectors that are pricing really well,” a market participant said.

“Cruise lines and travel still have a fair amount of volatility, which can produce terms like that.

“You have a high coupon at 17% and a big barrier as well.

“The volatility baked into these notes is definitely producing attractive terms.”

The implied volatility of Royal Caribbean Cruises is 50.77% compared to 16% for the S&P 500 index.

“I like the one-year period,” a financial adviser said.

After travel stocks rebounded as many expected a strong economic recovery, names like Royal Caribbean are now out of favor, he said.

The stock price has dropped significantly since the March 2020 level during the Covid sell-off.

“It’s still undervalued even though it has rebounded from a recent low in October. There’s been a little bit of buying since July. I would say it’s not overvalued, but it’s not a bargain either,” this adviser said.

The share price closed at $82.24 on Wednesday, a 60% increase from a low point in October. However, the price remains 40% off its pre-Covid level of January 2020.

“The downside at least is reasonable. 45% gives you a good size cushion,” this adviser said.

“To me, the main risk is to get your money back after one year. I see a high percentage chance to see the stock drop within that 40% range.”

Zoom Video

Another strategy is to make the most of the uncertainty preceding earnings announcement.

As the earnings date approaches, implied volatility usually goes up, allowing issuers to price better terms.

A recent example is HSBC USA Inc.’s $13.4 million of contingent income autocallable securities due Aug. 23, 2024 linked to the performance of Zoom Video Communications, Inc.

The notes will pay a contingent quarterly coupon at an annual rate of 10.25% if the stock closes at or above its coupon barrier, 55% of its initial level, on the determination date for that period, according to another 424B2 filing with the SEC.

The notes will be called at par plus the contingent coupon if the stock closes above its initial level on any quarterly redemption date.

The payout at maturity will be par plus the final coupon unless the stock finishes below its 55% downside threshold, in which case investors will be fully exposed to the stock’s decline from its initial level.

The market participant explained one of the factors behind the divergence in returns between the two products.

“They’re really two different structures,” he said.

“It’s reasonable to expect getting paid less here since you can earn your coupon if the stock is above the 55% barrier instead of initial level,” he said.

“Also, with the other, the Royal Caribbean one, you only get paid once. It’s not income. You get paid when you get called.

The implied volatility of Zoom Communications is 42.72%.

“I think in this case, they were able to pick up some volatility ahead of the earnings,” he said.

The notes priced on Aug. 20. Ten days later the company reported disappointing quarterly results, which pushed the stock price 10% lower.

On Wednesday, the share price closed at $290.86, or 13.6% off its $336.86 initial price.

“Investors had a negative outcome from the earnings, but they still have a 45% downside protection. Certainly, the price of the notes will take a hit right away,” he said.

UBS Financial Services Inc. and UBS Investment Bank are the underwriters for the notes linked to Royal Caribbean Cruises.

The notes (Cusip: 90300V653) priced on Aug. 26.

The fee is 1%.

HSBC Securities (USA) Inc. is the agent for the notes on Zoom Video. Morgan Stanley Wealth Management is the distributor.

The Cusip number is 40439K425.

The fee is 2.5%.

© 2015 Prospect News.
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