UBS’ $12.5 million airbag gears on S&P 500 show surprisingly wide buffer over short tenor

By Emma Trincal

New York, Aug. 17 – UBS AG, London Branch’s $12.5 million of 0% capped airbag gears due Sept. 13, 2024 linked to the S&P 500 index “surprised” advisers as it offered a large buffer on a very short maturity without sacrificing much on the upside. Callability and worst-of payout had been avoided by the issuer, rendering the terms all the more attractive, they said.

If the index return is positive, the payout at maturity will be par plus 125% of the index return, subject to a maximum return of 13.35%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is zero or negative and the final index level is greater than the downside threshold, 75% of the initial level, the payout will be par.

If the final index level is less than the downside threshold, investors will lose 1.3333% for each 1% that the index declines beyond 25%.

Short and sweet

“I kind of like the note. It’s a pretty well-balanced structure.

“We just don’t know where the market is going to be. That note is a good way to handle uncertainty,” said Steve Doucette, financial adviser at Proctor Financial.

The 13.35% maximum return was the equivalent of a 12.3% gain per annum on a compounded basis.

“That’s not a bad return. Do we expect the market to be up 12.3% in one year? Not sure, really. If it’s up more, that’s the only way you’re going to underperform,” he said.

The payout on the downside guaranteed that the notes would outperform the index.

“If it’s down, you’re going to beat the market with the 25% buffer. I would limit my outperformance to 15% on the downside. 15% is already pretty significant.”

Usually, short-term notes limit the size of buffers, he noted.

“25% on a 13-month is huge. I guess a little bit of volatility lately has introduced some flexibility. It’s nice to see that you can get such decent parameters on such a short-term note,” he said.

Big cut

Doucette said he would explore different terms for the notes. He would maintain the same leverage multiple and tenor in order to focus on the relationship between the cap and the buffer.

“Keeping those two parameters, I’d try to see what happens with the cap if I give up the full 25%,” Doucette said.

Doucette used one of his tools to price a note with a 10% buffer keeping the 1.25 times leverage and tenor unchanged. By cutting the buffer size, he was able to raise the cap to 14.6%.

“You’re getting 1.25% more in cap but you’re reducing the size of your buffer by a whole lot. From 25% to 10%; that’s a big cut,” he said.

Stretching the cap

At the same time, the current 25% buffer size of the notes reflected a particular market view, which may not match his own outlook.

“You’re making a bearish assumption when you put a 25% buffer on the downside. I’m not that greedy. Do I need 25%? I think 10% or 15% is nice,” he said.

But it would take a significant reduction in the buffer size to obtain a marginal increase in the maximum return, he added.

“You have to weigh in whether you lean toward the protection or the cap. Then you can decide if you want to give up an awful lot of downside protection.

“Now you’re in prediction mode. It’s a tough call because the market moves so quickly,” he said.

However, if he had to choose between leaving the large buffer as is or cutting it to expand the upside potential, Doucette said he would opt for the latter.

“With a buffer, I know I’m going to outperform on the downside no matter what. How do you ensure you can outperform in both directions? You need to raise the cap,” he said.

Pullback ahead

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he was “pleasantly surprised” by the buffer size.

“I like this level of downside protection, especially in this market,” he said underlying some of the risks investors are being exposed to.

“The market has started to slow down. The Fed seems to remain hawkish. In my opinion, the market has been a little bit overbought,” he said.

Medeiros was only moderately bullish.

“I’m not anticipating big returns in stock prices. The cap in my opinion offers enough upside potential. 13.35% is a good level. I’m not expecting the market to be much higher.”

Given his modest return expectations, Medeiros said he liked the leverage component as well.

“1.25 times is a decent leverage multiple. It could make a difference,” he said.

The best piece

But overall, the most attractive aspect of the note was the hard protection.

“I see a greater likelihood for a pullback.

“That’s why getting a 25% buffer on a 13-month note is very appealing. It’s rare to see such a generous buffer on a shorter-dated note especially on a single index,” he said.

Usually, Medeiros tends to avoid geared buffers. In this case the amount of protection was significant enough to alleviate his concern.

“It’s a big range of protection. Even if the index fell below that buffer threshold, the negative impact of the gearing would remain modest.

“This note is very appealing,” he said.

UBS Securities LLC and UBS Investment Bank are the underwriters.

The notes settled on Tuesday.

The Cusip number is 90279G3E7.

The fee is 0.1%.

© 2015 Prospect News.
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