GS Finance’s $1.17 million notes on Stoxx indexes boost leverage without overly dampening cap

By Emma Trincal

New York, Nov. 29 – GS Finance Corp.’s $1.17 million of 0% index-linked notes due Nov. 22, 2027 tied to the Euro Stoxx 50 index and the Stoxx Europe 600 index offer an unusually high amount of leverage making the notes attractive to moderately bullish investors, sources said. At the same time, the issuer was able to maintain an attractive cap level, expanding the scope of the investments to more bullish players.

If each index finishes at or above its initial level, the payout will be par plus 400% of the laggard index’s return, capped at par plus 84%, according to a 424B2 filing with the Securities and Exchange Commission.

If the worst performer declines but finishes at or above 70% of its initial level, the payout will be par.

If any index falls by more than 30%, investors will be exposed to the decline of the worst performing index from its initial level.

Euro play

“It’s really intriguing because the two assets obviously are highly correlated,” said a market participant.

The Stoxx Europe 600 index represents 600 large, mid- and small-capitalization companies across 17 European countries, including non-eurozone countries.

The Euro Stoxx 50 index tracks some of the largest companies across the eurozone.

“Usually when you have a worst-of the indexes are not highly correlated. Here you can get European exposure with a pretty solid correlation. It diminishes your risk.”

At the same time, investors may get a more diversified sector, market capitalization and country exposure to the region with the use of the two European benchmarks.

High leverage

But the market participant’s focus was on the relationship between the cap and the leverage multiple, which he found attractive on both ends.

“4x is pretty high and the 84% cap is not particularly low. You can end up with a 16% annualized compounded return. For someone with a modestly bullish outlook on Europe who wants some safety, it’s not a bad deal,” he added.

The underlying would have to rise less than 5% a year to bring the return to its maximum level, he said, making the notes suitable for a moderately bullish view.

Cap high too

Highly leveraged notes can be disappointing at times, but not in this case, this market participant said.

“I don’t need 4x to a low cap. Instead, I would take 2x to a higher cap. But here, you have 4x with a fairly high cap, and that can really give you a very good return,” he said.

Part of the pricing relied on the high dividends of the underlying indexes. The dividend yield on the Euro Stoxx 50 index and the Stoxx Europe 600 index are 3.3% and 2.8% respectively versus 1.55% for the S&P 500 index.

“Still, you have a good chance to outperform if you expect moderate returns.

“I’m not particularly a fan of 4x but with a cap as high as this one, it makes sense.

“I like the structure.”

Pricing

A sellsider explained how the issuer was able to price the highly levered product.

“We did something similar, but it was two-times, uncapped,” he said.

“Interest rates are still high, so it gives you more cash to put towards the options package.

“The worst-of is going to help too even though there is a high correlation between the two assets.”

Worst-of payouts produce a premium associated with the dispersion risk. The greater the correlation, the lower the premium.

The leverage is obtained by buying call options. The cost of those long calls can be fully or in part offset by the writing of call and put options, he explained.

“The implied forward volatility is elevated and you’re not just buying calls. You’re also a seller of volatility. For the barrier, you’re selling 70 out-of-the money knock-in puts. You’re also selling 184 out of the money calls.”

The short put option position creates the 70% barrier.

The short call position generates the 184% cap.

Since the initial price of 100 is higher than the strike price of 70, the puts are “out-of-the-money,” according to the option terminology.

The calls are out-of-the-money too because the initial price is below the strike price of 184.

“The writing of those options generates a premium. You can put it back in the notes and it allows you to buy the 4x upside exposure.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes settled on Nov. 22.

The Cusip number is 40057WVU8.

The fee is 0%.

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