Morgan Stanley’s autocallables on indexes offer high premium, one-year non-call

By Emma Trincal

New York, Oct. 18 – Morgan Stanley’s 0% jump securities with autocallable feature due Nov. 4, 2027 linked to the worst performing of the S&P 500 index, the Dow Jones industrial average and the Russell 2000 index should appeal to investors given its high and cumulative call premium as well as its one-year call protection feature with an exposure to diversified indexes, advisers said.

The notes will be automatically called at par plus 17.75% per year if each index closes at or above its initial level on any semiannual determination date after one year, according to an FWP filing with the Securities and Exchange Commission.

If each index’s final level is greater than or equal to its initial level, the payout at maturity will be par plus 88.75%.

If the laggard index declines but finishes at or above its 75% downside threshold level, investors will receive par. Otherwise, investors will be fully exposed to the decline of the laggard index from its initial level.

Low call, market risks

“It’s an attractive income-like strategy,” said Jeff Pietsch, founder of Capital Advisors 360.

“As volatility is rising in the market, it’s a great time to implement income strategies. You’re able to get some decent yield enhancement. In fact, the 17.75% is equity-like return.”

As with any autocall notes, investors must be willing to take reinvestment risk, he said.

“You have to accept to be called away, but you have this one-year no-call. And if you get called, you get called. You’re still getting a great return,” he said.

While investors may use the notes for income, they still have equity exposure. But the barrier and entry prices mitigate the market risk at maturity.

“The risk to the barrier is reduced because the market has been moving downward this year. You’re starting at lower levels,” he said.

From their respective January highs, the S&P 500 index and the Russell 2000 index have dropped more than 23% and the Dow Jones has shed 17.4%.

Early call

Another financial adviser said he liked the structure and the terms.

“The rate of return they’re offering is phenomenal. They were able to price it primarily because of the volatility in the market,” this adviser said.

“You’re not taking a huge risk on the short-term basis because of the cumulative premium. If you don’t get called in one year, chances are you will be called six or 12 months later. And you’re not giving up any return,” he said.

“So, let’s say we do go into a recession, and we do have a down stock market for several months or even a couple of years. Once you have a rebound you get called and you will capture the entire premium.

“That takes a lot of risk off the table.”

One-year non-call

The one-year call protection significantly reduced the call risk, he noted.

“With most autocalls, you’re most likely to get called out on the first call date, and with this one-year no-call, you’re likely to be called out in a year. That’s a nice 17.75% annual return,” he said.

Most autocallable notes, he added, tend to be called after three months, which can be frustrating for the adviser who spent time researching the deal.

“This one is much better,” he said.

Back testing

The early first-call assumption could be partially backed up by statistical data, he said.

“I really like this note even though it’s a worst-of. I usually like to assess the probabilities of various outcomes statistically. This being a worst-of, I can’t,” he said.

As a proxy, this adviser looked at the S&P 500 index’s historical performance since 1950.

“Since 1950, the S&P 500 over a one-year period has a 75% chance of being up. Three out of four times, you’re looking at getting called on year one,” he said.

“Now again, this is not a perfect estimate since you need some mathematical equations to integrate the different probabilities associated with three different indexes not perfectly correlated. But the chances are certainly greater than 50%,” he said.

Exit doors

Another risk mitigation factor was the frequency of the calls occurring twice a year, or nine times during the term, including the maturity date.

“You have a lot of opportunities to get called and that too reduces your risk. Usually, a bear market lasts about 24 to 36 months. You go down, you bounce back, you go down again and then you’re up. We’re already down 25%. Unless we’re in a very severe bear market like in 2000-02, you should be able to bounce back,” he said.

After the bursting of the Dot.com bubble in March 2000, it took at least seven years for all three underlying indexes to recoup their respective pre-crash levels.

No bears, no bulls

“If you’re very pessimistic, if you have the 2000 bear market in mind, you may be hesitant to buy this note because in this scenario, you’re not going to break even at any point in the next five years,” he said.

But all three indexes have already posted heavy losses this year. Both the S&P 500 index and the Russell 2000 are in bear market territory from their 52-week highs of Jan. 4.

“If you think the situation won’t improve in five years, if you have to be so pessimistic, you probably shouldn’t be in the stock market,” he said.

The notes are not appropriate for bullish investors either, he added.

“If the extreme bear would not look into this note, the extreme bull wouldn’t like it either. If you expect equities to be up 25% or 30%, you don’t want to get locked in,” he said.

Barrier

Finally, the duration of the trade and the barrier gave investors some level of comfort even if faced with the worst-case scenario.

“Assuming the bears are right and that the market is down for three years like in 2000, 2001 and 2003... the chances of losing money at maturity are very slim with the barrier,” he said.

“The idea that the market could be down more than 25% in a five-year period is far-stretched.”

The S&P over the past 72 years has dropped more than 25% over a five-year rolling period less than 1% of the time, he said. For the Russell and the Dow, that frequency has been 0.8% and 0.4% of the time, respectively.

“That tells me that even under very negative circumstances you still have a very good barrier in place.

“I like the deal,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Oct. 31 and settle on Nov. 3.

The Cusip number is 61774HSM1.

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