Scotia’s autocallable bear notes on S&P offer ‘favorable’ bet against market, contrarian says

By Emma Trincal

New York, Nov. 3 – Bank of Nova Scotia’s 0% autocallable bear Strategic Accelerated Redemption Securities due November 2024 linked to the S&P 500 index are designed for bearish investors who expect the market to drop within the next 12 months. Given that the scale of the downturn will not impact the payout amount, the odds of winning are compelling for bears, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, who is himself negative on the index for the period.

The notes will be called at par plus a premium of 33% to 34% per year if the closing level of the index is less than or equal to its starting value on any quarterly valuation date, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called at maturity, investors will lose 1% for each 1% gain in the index.

No protection

“There’s no downside protection if the market is up, so they can afford to offer a generous payout,” he said.

Investors had a good chance to win their bet in his view.

“The probabilities of the S&P being negative in one year or sooner is quite high,” he said.

“It’s a very favorable note because even if the market only drops a little bit, you’re still getting a very high premium.”

November

Kaplan said the odds of an automatic call at some point during the term of the notes were favorable. Only the timing of the early exit was uncertain.

The call may occur on only four observation dates – in February, May, August and November.

The likelihood of an early call in February was hard to assess as the notes have not yet priced. The trade date is set for the end of November.

“A lot of it depends on what happens this month,” he said.

“If we see a big drop in November, if the market collapses before pricing, the chances of a February call will be lower.”

He explained why. If the notes were to price after a big drawdown, the market may stabilize or even rebound, which would lead the index ‘price to surpass its initial level. This in turn would prevent the call from occurring due to the bearish payout.

July peak

For Kaplan, the U.S. market is in bear territory and has been since early last year.

“The S&P has been pretty strong this year, which was driven by the AI hype, but it has been going down since the end of July,” he said.

The S&P 500 index jumped 21.5% from the beginning of the year to its July 27 high. Right now, the year-to-date return is only 13.5%.

Even though the S&P 500 has recently been rallying since the end of October, the trend is still clearly bearish, according to Kaplan.

“The peak was Jan. 4, 2022. Then the market dropped and bottomed in October 2022. From there, we had a big bounce driven by the AI bubble, but it ended in July.”

To be sure, the market has rebounded since the end of October. But for Kaplan, this trend is part of the unfolding of a bear cycle.

“We had several rebounds since January 2022 but each time we’re doing a series of lower highs. That’s what a bear market really is. The market runs into resistance and what you see is a series of descending peaks,” he said.

The “AI bubble,” is a major factor of instability, he noted.

“Only a few stocks have been driving the rebound in the first half of this year up until July. But those names are in a bubble.”

Some stocks like Nvidia Corp. for instance have more than tripled this year.

“These big tech stocks with extreme valuations are going to drop significantly within the next 12 months,” he said.

Holding it

Investors would benefit from a later call.

“It may work out better for you if the call happens in May or in August because you would get a bigger percentage gain,” he said.

One advantage of an automatic call is that it removes uncertainty and with it all risk exposure.

But for Kaplan, the risk of principal loss at maturity was limited.

“We already are in a bear market and this one is going to be exceptionally long and severe,” he predicted.

“I don’t expect the market to be up a year from today.”

Prolonged bear

His forecast was based on a study of past bear and bull markets.

“The bull market from March 6, 2009 through Jan. 4, 2022 was the longest in history. So, I believe we are probably in the longest U.S. bear market in history,” he said.

As measured by the S&P 500, Kaplan does not expect the bear market to end until sometime in 2025, and possibly not until 2026 for some sectors.

“Since it’s going to be a long-lasting bear market, you’re likely to be in the money in one year if you haven’t been called sooner. The odds of losing principal I think are very small,” he said.

Call premium

Kaplan found the 33% to 34% annualized call premium exceptionally attractive.

“That’s probably the highest rate of return of any investment I know. And it certainly would be very good to lock in that type of gain in a bear market,” he said.

The call premium as a form of payout offered another advantage.

“You’re really betting on the direction of the market, not on the magnitude of the drop. The note doesn’t care how much the index is down. As long as it’s negative you will get paid regardless.

“This is a good note to have,” he said.

BofA Securities, Inc. is the agent.

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