Leveraged Capped return Notes on SPX - Should one invest?

HSBC has created a Note with 3 times leverage and maximum profit capped at 10% with a maturity of 14 months. On the down side this note will participate 1 to 1 in down side performance. After reviewing this note with the lens of our Quantitative metrics we think this is note is not for a conservative faint hearted investor. As this note exposes the investor to complete downside performance. One should be careful to invest in this kind of note.


 I gotten interested to analyze this note for few reasons. Firstly, size of the note is 162 Millions. Considering the issuance sizes of various notes, this is note is of relatively large size. Looks like some big institutional client is need of this well crafted exposure to SPX over 14 month period. Alright, second reason for choosing this note is the return profile. This note provides 3 times leverage with return capped at 10%. This means, investor will benefit if SPX rises by 10% only. If SPX rises beyond 10% then note underperforms the underlying index. On the other hand,if SPX Index falls from the initial level investor is exposed to that down performance.

This kind of profile where return is capped with full down side exposure is a very common theme that we have been seeing. We have seen, notes created on single names and indices alike, issuers have created this leverage capped notes with down side exposure.

This type of note cannot be analyzed in isolation to understand the significance of its creation. Rather there are some specific hedging needs that needs to be understood to get the context of the note issuance.

This means not all structured notes are created same. Each one has a unique investment thesis and purpose. One has to understand them to appreciate the creation of the structured Note and before investing.

Accelerated Note on SP 500 by HSBC

Volcker Rule - Some Facts around Quantitative metrics

Volcker Rule is another regulation aimed at restraining banks from engaging proprietary trading. This rule has various components to it. Some aspects deal with compliance program and rules, few other pertains to Quantitative metrics and reporting requirements. I have focused this article on few facts around how trading desks will conduct their quantitative metrics reporting and interpretation.

My observations:

1) Volcker Metrics requirements create huge reporting requirements for the banks at trading desk level
2) Fed examiners will have tough time to interpret some of these metrics as calculation methodologies are highly arcane.
3) Banks will have to build out the Volcker story to provide the details of why and how they can be exempted for market making activity.
4) I strongly think if transparency in reporting the trading activity happens then there will be no need for any kind restraints on market making activity.
5) FED should leverage the SDR data from depositories  to analyze the banks. As it contains all the information pertaining to transactions
6) I definitely like the inventory metrics and they can help understand the desk trading whether it is customer facing or not
7) Volcker rule another requirement of RENTD ( Reasonably estimate near term demand). I think this one will be difficult to estimate.

Lastly, Volcker rule wants to restrain bank trading activity but, trading is like flow of water flow. If you put restraint in one direction then it water will find its next path of flow.

Below is the detailed version facts on Volcker rule.

  Volcker rule facts on metrics

Structured Note Issuance Summary – July week 1-5, 2014

During the week of July 1-Aug1, 2014 structured note issuance has been 60.9 Bn across various issuers and asset classes. Most of the issuance (4.4 Bn) is driven by Equity Linked notes and 56.3 Bn of the issuance is driven by Interest linked products. There has been some activity in commodity linked issuance this week. For Details of the distribution refer to the chart below. Not surprisingly majority of the structured note issuance is linked to Interest rate linked by few issuers.

This week, structured notes were issued with variety of flavors and interesting themes. Majority of this issuance comprised of Interest Rate related notes Read on for more details.

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You can click individual asset classes to see how the underlying issuance has happened within each asset type by underlying and Issuer.

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Underlying analysis

On the Equity linked notes front there has been strong activity. Notes have been created on variety of underlyings. Index related issuance has been significant. This week issuance included notes created on the indices ( S&P 500, Stoxx 50, Russell 2000) and single names ( Face Book, Amazon, Pulte Group, Apple, Yahoo and so on). There has been significant activity around basket linked notes.

Comparing this week to last week there’s more notes being issued. Among the high notional notes is the $162 million on the SP 500 by HSBC. Another one by HSBC is on KBW Bank Index for $86.5 million and a second one with $30.8 million. Morgan Stanly also issued a note on the same KBS Bank Index for $40.5 million. Bank of America played two different notes on the S&P Oil & Gas Exploration and Production Select Industry Index for $55.9 million and $61.4 million. Bank of America also issued a $54.88 million notional note on the PHLX Housing Sector Index.

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Interest rate linked issuance limited to standard, step up callable notes and Fixed rate notes. Activity has been subdued this week.Citigroup, RBC and few other major issuers of these products.

This week we have seen commodity note issuance tied to Commodity Baskets and Crude Oil by Morgan Stanley..

Size of the note types will tell us an indication of what type structures are popular among the investors and where money is flowing. Below chart shows this theme

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Popular notes have been interest rate linked notes. Now moving on to issuers side and understanding their market penetration or competitor analysis provides some interesting insights. This week UBS, MS, GS and Barclays captured issuance market share.

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Market penetration is driven by the issuer depth in each of the asset classes. Every issuer has presence in Equity linked issuance. Goldman is only issuer to produce Currency related issuance. Morgan Stanley and JPM are active players in the Hybrid related issuance.

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Autocallable Yielding 17% per annum on Tesla Motors by Barclays

Barclays has created a new structured note on Tesla motors. This note is interesting for two reasons. Last week we have noted how reverese convertible notes created on Tesla Motors by JP Morgan and RBC were different only by 75 basis points in coupon.

Firstly, Barclays also joined the bandwagon of issuers creating structured notes on TESLA motors. Secondly, they have increased the stakes by sweetening the deal with 17% coupon per year. Now they managed to increase this higher coupon by adding the auto callable feature.

Our quantitative metrics were based on historical data of last 4 years. Since this period relates to post financial crisis and stocks were rising from their rock bottom lows. This might not be sufficient to generate metrics. With that said, looking at metrics suggest this is a great investment with very little risk an investor can get.

Our risk score of 3 and probability of sure win is making this note very interesting for us.

Gatick advises investors to look for or create structures similar to this auto callable to make good return on their investment.

We are more than happy to go over the nuances of the underlying options and their risks.

Auto callable TESLA

Structured Note Issuance Summary - July week 4, 20014

During the week of July 1-25, 2014 structured note issuance has been 44.3 Bn across various issuers and asset classes. Most of the issuance (2.75 Bn) is driven by Equity Linked notes and 41.4 Bn of the issuance is driven by Interest linked products. There has been some activity in commodity linked issuance this week. For Details of the distribution refer to the chart below. Not surprisingly majority of the structured note issuance is linked to Interest rate linked by few issuers.

This week, structured notes were issued with variety of flavors and interesting themes. Majority of this issuance comprised of Interest Rate related notes Read on for more details.

Learn About Tableau

You can click individual asset classes to see how the underlying issuance has happened within each asset type by underlying and Issuer.

Learn About Tableau

Underlying analysis

On the Equity linked notes front there has been strong activity. Notes have been created on variety of underlyings. Index related issuance has been significant. This week issuance included notes created on the indices ( S&P 500, Stoxx 50, Russell 2000) and single names ( Face Book, Amazon,Pulte Group, Apple, Yahoo and so on). There has been significant activity around basket linked notes. Looks there is high appetite from institutional investors to conduct their portfolio balancing process.

This week has been a slow week with most of the issuances taking place on Tuesday. There are a few interesting notes. The DAX Index was used as the underlying for three of them. Deutsche Bank issued a note on Delta Air Lines, Inc for total notional $11.9 million. One of the bigger notional was issued by J.P Morgan at $148 million on the J.P. Morgan Enhanced Beta Select Backwardation Alternative Benchmark Total Return Index. Another interesting note is by Barclays on the International Paper Company as a Synthetic Convertible Note at a notional of $41.7 million. Finally UBS used a different variation of their usual notes by issuing Phoenix AutoCallable Notes for six different companies at $500,000 each.

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Interest rate linked issuance limited to standard, step up callable notes and Fixed rate notes. Activity has been subdued this week.Citigroup, RBC and few other major issuers of these products.

This week we have seen commodity note issuance tied to Commodity Baskets and Crude Oil by Morgan Stanley..

Size of the note types will tell us an indication of what type structures are popular among the investors and where money is flowing. Below chart shows this theme

Learn About Tableau

Popular notes have been interest rate linked notes. Now moving on to issuers side and understanding their market penetration or competitor analysis provides some interesting insights. This week UBS, MS, GS and Barclays captured issuance market share.

Learn About Tableau

Market penetration is driven by the issuer depth in each of the asset classes. Every issuer has presence in Equity linked issuance. Goldman is only issuer to produce Currency related issuance. Morgan Stanley and JPM are active players in the Hybrid related issuance.

Learn About Tableau

Learn About Tableau

Learn About Tableau

Reverse Convertibles on TESLA by Royal Bank of Canada and JP Morgan

Reverse convertible notes are mostly criticized by variety market participants for causing huge losses to investors. Despite that fact, we see there is insatiable demand for these notes. This kind of demand is not only prevalent among investors but there is race among issuers to create these notes for their investors.

Myself and my associate Karthik Sharma have looked at reverse convertibles created by JP Morgan and Royal Bank of Canada to their investors on TESLA Motors.

For these two notes, Structured note investment analyzer are provided for details around the Investment theme, Investment metrics,Investment performance and finally around Investment commentary.

Few observations came out from comparing two notes.

1. Notes are created with similar terms of maturity with slightly better coupon by Royal bank of Canada (RBC)
2. JP Morgan note has higher commissions compared to RBC note. I think this commission matters only on the day of note creation. When you look at a note value along with commission it will be equal to your initial investment. For an investor this commission should not be a big factor to make decision.
3. RBC Note provided higher coupon (75 bps ) than JP Morgan note. This suggests RBC has sweetened the deal to attract investors to this note.

Overall I think investors should be indifferent to issuers for these reverse convertibles when these notes are provided on similar terms.

Post financial crisis, people are focusing CDS spreads to evaluate the credit worthiness of the issuer. For a 3M note, RBC or JP Morgan CDS spread will be a technical point rather than a game changer. 

Investors first need to understand the investment theme. In this case, what kind of growth potential in Tesla stock vs structured note. 

Tesla Motors, Inc. (TSLA) stock had been performing well over the last few months. The stock rose from $149.56 to $224.54 by July 24th, 2014 increasing almost 50% since January. This is due to variety of new strategic developments that have resulted in the stock price growth. Notable news the open sourcing of its patents and the introduction of the CUV known as Model X and a smaller sedan known as the Model III. This stock might pull back temporarily but has good potential for appreciation. This would suggest stock has high probability to move with in a narrow range.

Next, Investment metrics need to be looked for making a determination whether the investment theme makes any sense. After analyzing investment metrics, review the note performance in historical and future stress scenario context. Combining all these 3 elements one should look at investment recommendation.

I think note from RBC offers a better deal compared to the Note from JP Morgan.

Reverse Convertible on Tesla by JPM by chandkhand2

Reverse Convertible Tesla RBC by chandkhand2

Structured Investment analyzer - Autocallable note on SP500 from Credit Suisse

Today we have analyzed an autocallable note from Credit suisse. This note looks very interesting because it provides investor with higher coupon compared to other investment alternatives like treasuries but with reasonable risk. As we all know SP 500 has been trending upwards after the great financial crisis. This can be attributed to FED's Quantitative easing program, good economic recovery and lower unemployment. Investing in the index is a good way to gain exposure to this market. Major issue is we do not know a priori when to exit the market. I think structured note with its predetermined pay off profile will let investor decide how much return he would like to make on the investment and also corresponding loss on the investment. This way one can design a note and then check its performance historically and also verify how it might behave in future using market simulations. We have done these tests to the note designed by the Credit suisse. We think Note has done well with 3y maturity but Karthik (from Gatick Global solutions) is arguing that this note would be better if the maturity is either 2y or 4y to reduce the down performance outcomes. I kind of like this argument as it is based on the rise of the market and followed by a recession and recovery theme. Also, I think due to its low volatility ( 11.5%) and low risk score for some investors this is a good investment. Investors and Advisers should make use of this structure of this kind of note for different underlyings. contact us for any advise on understanding the risks for this kind of note.

SP500 Auto Callable Note by chandkhand2