UBS’ $110,000 trigger return notes on Amazon may offer high leverage, modest cap

By Emma Trincal

New York, Aug. 12 – UBS AG, London Branch’s $110,000 of trigger return optimization securities due Feb. 15, 2024 linked to the common stock of Amazon.com, Inc. offer an unusually high amount of upside leverage, noted Clemens Kownatzki, finance professor at Pepperdine University, who questioned the rationale of capping and quintupling the gains of a “high-flying” stock such as Amazon.

If Amazon’s stock finishes at or above the initial price, the payout at maturity will be par plus five times any gain, subject to a maximum payout of par plus 29.13%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the stock declines but finishes at or above the 75% trigger level and will share in any losses if it closes below the trigger level.

Roller coaster

When the notes priced on Wednesday, Amazon closed at $142.69, or 41% above its low of May, Kownatzki said.

“For a stock to rebound that much is quite remarkable. At the same time, we are 25% lower than where we were back in November.”

From its November high at $188.11 to its low of May 24 at $101.26, the share price plummeted nearly 46%

The magnitude of the price moves both downward and upward demonstrate the high volatility of the stock.

For that reason, Kownatzki questioned the soundness of combining a capped upside participation with a leverage multiple of 5.

Low and easy cap

The 29.13% cap for the 18-month tenor is the equivalent of an annualized compounded return of 18.6%, he said. But with the 5x leverage, it only takes a 3.85% annual return for the share price to hit the cap.

“The cap gives you a decent return. But they make it easy to get there. If the stock is only moderately up, you’re almost guaranteed to get the maximum return, which is close to 19% a year,” he said.

“If you’re bullish on Amazon, it’s a little odd to need so much leverage for a return that’s likely to be way below your expectations. If the stock is up more than 4%, you’ve already hit your cap. That’s not exactly a huge rate of return for a company as successful as Amazon.”

The cap itself was somewhat “disappointing,” he added.

“I’m not sure why you would need five times the return to get to less than 20% a year. You can achieve that type of gain over a much shorter period of time if you’re long the stock,” he said.

“Hasn’t Amazon gone up more than 40% in the past two-and-a-half months?”

He was referring to the move from the May 24 low to the price on the trade date.

The high volatility of the stock made the investment risky on the downside too, he said.

“You get into this trade at a high entry price. And you only have a 25% barrier. For such a volatile stock and over such a short timeframe, I’m not sure you’re getting enough protection,” he said.

The barrier level is at $107.

“It’s a little bit above where we were in May. So I think the downside protection is a bit shallow,” he said.

Stock market up

Amazon, but also the overall market, has rallied since June, he added.

“Is it the upper move of a bear market or is this market going to continue to be strong? It depends on who you’re asking. There are very different opinions,” he said.

“If you think geopolitical tensions are going to get worse in Europe or in Asia, if you expect a recession, Amazon is better positioned than many stocks because of its online retail business model. We’ve seen it clearly during the pandemic,” he said.

Inflation and valuations

The recent report on a vibrant job market eased some of the recession fears but reignited concerns about inflation.

“A persisting inflation is not good for growth stocks like Amazon. It hurts their valuations. Rising rates increase the discount rate used to value those richly valued stocks. No one knows how quickly and how efficiently the Fed will be able to tame inflation without avoiding a recession. I’m not quite as convinced as the Fed that they can bring inflation to 2%,” he said.

Assessing the long-term impact of inflation on stocks like Amazon is challenging, he said.

“But we lived under a very low inflation environment for a long time, and we know how much it helped bring the valuations of growth stocks to extremely high levels. A continued inflationary environment is likely to have the opposite effect, bringing those valuations down.”

The wrong stock

For Kownatzki, the structure may not be helpful to investors.

“The question I have is: do I really need this note? If I have a positive view on it, I’ll probably be capped out with my principal tied up for 18 months,” he said.

Instead, he would buy the stock for liquidity purposes, he said, adding that he would then put stop orders on his position or hedge it with options.

“I don’t really understand the rationale behind this trade. Why massively lever up a high-flying stock like Amazon with an easy-to-reach cap? It’s one thing to do that with a utility company or a traditional blue-chip. In that case, yes, the super leverage makes a lot of sense. But with Amazon, it’s just odd in my opinion,” he said.

“If you are moderately bullish – and I am moderately bullish on Amazon – you should really buy the shares.”

Alternatives

Even the downside protection did not measure up.

“People buy structured notes mainly for the protection. They’re willing to give up some of the upside for the barrier or the buffer. But that type of tradeoff doesn’t quite work here,” he said.

“It’s a relatively short-term note. It could go down a lot and back up again. Who knows? But it’s volatile enough to breach the 25% barrier in no time.

“If you’re bullish or bearish on Amazon, buy the stock. You can get in and out when you please.

“If you’re not, if you happen to have a range bound view, then why not do an autocall? Chances are you’ll get called pretty early anyway. But at least you have the coupon.”

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes settled on Friday.

The Cusip number is 90303Q768.

The fee is 1%.

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