Goldman Sachs' index-linked trigger notes linked to S&P 500 fit range-bound market view

By Emma Trincal

New York, March 21 - Goldman Sachs Group, Inc.'s 0% index-linked trigger notes due April 9, 2014 linked to the S&P 500 index are designed for investors who are unsure about the direction of the market while not foreseeing any wide moves either up or down.

The structure offers a 20% contingent protection over a short period of time, which is its main appeal, sources said. On the other hand, the downside trigger can be hit at any time while the upside is capped with no return enhancement.

"It's one of these notes where you're capped on the upside with unlimited downside and you have no leverage," Steve Doucette, financial adviser at Proctor Financial, said.

"It's for somebody who wants the index exposure and thinks the market will trade sideways; they have to believe there won't be a 20% decline at any point."

A trigger event occurs if the index level falls by more than 20% during the life of the notes, according to a 424B2 filing with the Securities and Exchange Commission.

If a trigger event occurs, the payout at maturity will be par plus the index return, which could be positive or negative.

If a trigger event does not occur, the payout at maturity will be par plus the greater of the index return and the contingent minimum return of 0%.

In either case, the cap will be 15%.

Any time

"The strength of the structure is on the downside provided that you think that the market is not going to fall 20%," Doucette said.

"If the market is down but doesn't hit that 20% trigger, then I guess it would be one way to outperform the index. But even then, you never know what the momentum is going to be like. You really have to believe the market won't move that much."

Doucette said that even if the 20% protection appeared to be good relative to the one-year term, the measurement of the trigger was not attractive.

"A lot of the notes I see have a barrier at maturity. With this one, you can break it any day. Having a final barrier makes a huge difference. You never know when that little Cyprus crisis is going to happen. If it does at some point during the one year, you've already knocked out your protection," he said.

No boost

For Doucette, investors pay for the barrier with a limited upside, which suggests the investor would have to be bullish enough to expect growth with a simple 100% participation in the upside.

"They could have improved the product by giving you some digital return or some leverage. Even with a lower cap, it may have been more reasonable on a one year," he said.

The tenor could have also been modified to enhance the upside, he added.

"They kept the maturity short, but at the same time, it doesn't give you any upside. If you start adding time, you get to do a lot more with caps and barriers. Might have been a good way to introduce some leverage ... it would have been good."

Doucette said that "for folks who don't believe the market will do anything, having a 15% cap is a decent range for this index exposure."

But he still did not like the asymetrical payout.

"Again, when I see an unlimited downside and limited upside, I never consider that a good tradeoff. I think I could do without the notes," he said.

Range bound

Michael Iver, founder of iVerit Consultancy and former structurer, said that the notes were designed only for mildly bearish or mildly bullish investors, not for those who foresee wide market moves. From that perspective, he said that the notes provided investors with a good level of downside protection over a relatively short time combined with an attractive cap.

"This is for someone who thinks this market is going to be quiet or might even be a little bit down but not too much, so that they can still benefit from the downside protection. In one way, it's a mildly bearish play," he said.

"You're selling volatility. You get 100% participation in the upside up to 15% and you will enjoy protection up to 20% on the downside.

"When you think of a 20% decline in the benchmark, it's not a correction, really. It's a crash. A correction would be 10% down.

"So if there is a crash, which I don't expect if I invest in these notes, then yes, in that case I lose all my protection. In this scenario, the 15% cap would be irrelevant because assuming the market finishes back up, I would be almost grateful to pocket the 15% maximum return.

"This note is designed for the mildly bullish and mildly bearish investor, someone who has a range-bound view of the market, a range between minus 20% and plus 15%."

American versus European

Iver agreed that a trigger event observable on any trading day was one of the drawbacks of the product, making it in appearance less appealing than a final barrier.

"But you have to look at what you're getting for that: you're getting a 20% protection on a one-year term.

"It's precisely because you have this any-day type of trigger, this American type of option, that you can get such protection.

"You're getting a great protection because the issuer has the right to take that protection away from you.

"They're buying this right from you, and they're paying you for that.

"If you had a final barrier on a one-year note tied to the S&P 500, you wouldn't have anything as wide as a 20%," he said.

The low levels of volatility on the S&P 500 as measured by the VIX index create another challenge for the issuer, he explained.

The VIX last week hit a five-year low at around 11. It was back up on Thursday at nearly 14 but has been trading below 13 for most of March.

"The VIX has come in a lot. It is as low as I can remember," Iver said.

"So a one-year note with a 15% cap and a 20% downside seems pretty good relative to where volatility is.

"If the VIX was at 20% compared to the 11%-13% levels it is at now, there would be a greater likelihood of breaching this barrier.

"If you believe the markets will be more volatile than what is implied, then you have to be careful about this deal.

"But if you think the market will be range bound, it seems pretty fair to me," he said.

Goldman Sachs & Co. is the underwriter, and J.P. Morgan Securities LLC is the placement agent.

The notes (Cusip: 38141GQY3) are expected to price Friday and settle March 27.

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