Barclays' Accelerated Return Notes linked to Energy Select provide unusually high leverage

By Emma Trincal

New York, Aug. 16 - Barclays Bank plc's upcoming 0% Accelerated Return Notes due August 2013 linked to the Energy Select Sector index offer an unusually high leverage multiple facilitated by the recent rise in volatility, said Lee Kramer, president of Capital Management Analytics.

"It's a little unusual. I've seen two or even three times leverage, but not five," he said.

"With implied volatility being so high, they're able to magnify the leverage."

The payout at maturity will be par of $10 plus five times any gain in the index, up to a cap of 37% to 41%, according to an FWP with the Securities and Exchange Commission. The exact cap will be set at pricing. Investors will be exposed to any losses.

"The trade-off for the leverage is the cap, but it's mostly the absence of any downside protection," he said.

"This is a note for someone who is not wildly bullish on energy stocks. If you were, you wouldn't want the cap."

Call spread

Kramer said that the issuer structured the product replicating a "call spread."

"You can make the same moderately bullish bet using an option," he said.

"The investor would buy a call spread on the Energy Select ETF going out two years. One leg of the trade would consist of buying a call on the ETF. The other would be to sell an out-of-the-money call with a strike price above the strike of the call you purchased.

"The sale of the call is what allows you to reduce your cost."

Kramer said that the advantage of a call spread with options is that it reduces the downside risk.

"All you can lose is the price you spend on buying the call.

Selling the put

Because the call spread is cost efficient, it enables the issuer to offer the leverage.

But the bulk of the upside leverage is financed through the sale of a put, he said.

"With the market so volatile, puts are very expensive to buy right now. So you get a lot of money from selling them," he said.

"The strike is the initial price, and you have full exposure to losses.

"Problem with the put sale embedded in those notes is that it takes away the advantage of a call spread because you, the investor, have now all the downside risk. This is why I don't like the deal.

"If you have to go out two years, and two years with this asset class is a long time, you might as well get some downside protection.

"I would think you would be better off with a call spread as it limits your downside risk."

Capped for bulls

But Matthew Bradbard, president of MB Wealth, a commodities brokerage firm, said that he is comfortable with the risk/return profile of the notes.

The maximum annualized return for the notes, 18.5% to 20.5%, makes the product very appealing to bulls, he said.

"Twenty percent a year: that's pretty bullish in my book," he said.

Bradbard said that he is "very bullish" on both oil and natural gas, the two main sectors tracked by the index.

He said that both oil and natural gas are trading at mid-range from their respective highs and lows of the past three years.

For crude oil, the peak was $147 a barrel in July 2008 and the low was $33 in the early part of 2009.

"Trading now at $87, we're just at mid-point," he said.

For natural gas, the current price is about $4 per 1,000 cubic feet, which is also in the middle of the range. The peak at $13 was in July 2008 and the low at $2.50 was in September 2009, he said.

"I'm bullish for the next two years on both," he said.

"To me, oil could easily go back to $115, even $125 in the next 12 or 18 months.

"And natural gas is one of the best commodities to buy right now at those levels.

"I like natural gas more than corn, coffee, silver or gold.

"This is a very good deal. With the 25% correction in oil we've had in the past three months, I think it's a good entry point."

The notes will price and settle in August.

Bank of America Merrill Lynch and Barclays Capital Inc. are the agents.

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