Goldman Sachs' $40.84 million trigger notes tied to S&P 500 well bid due to structure, agent

By Emma Trincal

New York, Sept. 14 - Goldman Sachs Group, Inc.'s $40.84 million of 0% index-linked trigger notes due Sept. 26, 2012 linked to the S&P 500 index headed up last week's modest action partly due to the appealing structure of the offering and partly because of who sold it, sources said.

Goldman Sachs & Co. was the underwriter with J.P. Morgan Securities LLC as placement agent.

The notes offered a contingent minimum return in the absence of a trigger event, according to a 424B2 filing with the Securities and Exchange Commission.

The trigger event occurs if the index closes below the trigger buffer - 80% of the initial level - during the life of the notes.

If a trigger event never occurs, the payout at maturity will be par plus the greater of the index return and 13.5%. Otherwise, the payout will be par plus the index return, with exposure to losses.

In either case, the return is be capped at 20%.

'It works'

"This is not a new structure; it's something we see quite often, but it works. It's popular because the idea behind this is simple," a market participant said.

The rationale behind the deal, he said, is a simple trade-off: The investor gets more protection but gives up some of the upside and the dividends on the view that the underlying price may not fall by more than the buffer amount.

"People are taking some protection based on the barrier, thinking that at these entry points, the odds of the index going down 20% are slim," he said.

When the market sells off as it is the case now, those structures gain more traction.

"I'm not surprised that you're seeing some interest in these kinds of notes," he said.

In addition, the product offers the same exposure to losses as a stock with potentially more upside if one is not overly bullish on the market.

"The use of derivatives gives you an alternative to buying a stock," the market participant said.

"As long as the S&P doesn't fall by more than 20%, you're protected against losses. And even if it does, you're not worse off than buying the stock itself. It's a very powerful proposition."

Trade-off

In order to benefit from the downside protection, investors have to agree to a cap on the upside.

"That's the trade-off," the market participant said. "You forego the opportunity of generating gains of more than 20%.

"For only one year, that's not a very big deal. Investors would much rather take the protection for that."

The market participant said that "to be fair," investors do not just give up returns of over 20%. They also forgo the dividends they would earn if they held the equity directly.

The indicative dividend yield for the S&P 500 right now is 2.2%, he said.

"From the investor's perspective, it's still attractive to give up the 2.2% dividend and the upside above the cap for the 20% protection on the downside," he added.

Hybrid

While simple to understand, the structure is also a hybrid between a reverse convertible and a leveraged return note, he said.

The similarities with the reverse convertible notes lie in the downside protection established through the use of a barrier rather than a buffer, he noted.

The trigger price can be hit anytime during the life of the notes, eliminating the protection once the trigger event occurs, which puts 100% of the principal at risk, a important difference from the buffer.

The common aspect with a leveraged return note, he said, is to be found in the possible enhanced upside.

"You're not getting two times the return of the index, but you do get a contingent minimum return. It's a form of enhancement as well," he said.

Big agent, big deal

Others felt the deal was well bid because JPMorgan was behind it.

"JPMorgan likes these kinds of transactions. They sell a lot of them," a sellsider said.

"I like those transactions, but I don't know if this one is good or not. I would have to price it up myself and check volatility levels [of] the options," he said.

The offering priced on Friday at the S&P 500 closing level of 1,154.23, very near the 52-week low observed a month before at 1,119.

"Is it a good entry point for the S&P 500? Unfortunately, it's been a good entry point for a few weeks now and it keeps getting better," the sellsider said.

"I'm not saying the deal has no merit, but usually, when you see a deal that size, it's mostly about distribution."

Fees were 1.1%.

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