Morgan Stanley’s dual directional buffered notes on indexes built to play defense

By Emma Trincal

New York, Nov. 10 – Morgan Stanley Finance LLC’s 0% dual directional buffered participation securities due Nov. 29, 2023 linked to the worse performing of the Nasdaq-100 index and the Russell 2000 index are designed for investors seeking to gain from a modest market decline without sacrificing all the upside, sources said.

If each index finishes above the initial level, the payout at maturity will be par plus the gain of the laggard index up to a maximum payout of par plus 27% to 32%, according to an FWP filing with the Securities and Exchange Commission. The actual maximum payout will be set at pricing.

If either index falls but not by more than 15%, the payout will be par plus the absolute value of the return of the laggard index.

Otherwise, investors will lose 1% for each 1% loss of the lesser-performing index beyond the buffer.

Downside edge

“You’ll outperform on the downside,” a market participant said.

“Some people may prefer more upside, some leverage or a higher cap. Others are more comfortable with a defensive product like this one. There are products for almost any investor in the world. It makes sense to have buffer plus absolute return the market being where it is. We just hit another record high.”

Trade-off

It has become more common to see directional notes also known as absolute return that offer a buffer in place of the more common barrier.

“It’s going to be a different trade-off,” this market participant said.

“You may have a lower cap with a buffer. This one may only be 27% over three years. If it was a barrier, you may have more depending on the barrier size obviously.

“Bulls would push for leverage, a higher cap, and if they could, no cap at all. That would be a totally different note. Your terms on the downside would be considerably less attractive.

“People buy notes based on their market outlook. This one is for someone who is mildly bullish and moderately bearish for the next three years.

“A structure is an assemblage of options. Numbers don’t lie. If they did, the banks would lose money.”

Protection size

Mark Dueholm, chief trader at Landolt Securities, said he prefers barriers.

“We tend not to do participation notes with buffers. We do trigger notes instead. We like barriers because they give you a bigger cushion, one you couldn’t get with a buffer,” he said.

With the notes, an index price decline between 15% and 30% would generate a loss, he explained while a 70% barrier would not.

“We typically do trigger issuer call notes,” he said.

The discretionary call and the barrier protection allow for the pricing of competitive coupon rates, he noted.

Buffers first

Tom Balcom, founder of 1650 Wealth Management, said he liked the notes for risk-averse investors.

“We like buffers in general,” he said.

“Our portfolio consists mostly of buffered notes.

“With a barrier, when the market sells off and you breach, you lose potentially everything. The protection is knocked out.”

Worst-of

One of the risks associated with the structure was the choice of the two indexes for the worst-of.

“The Nasdaq and the Russell are less correlated than Nasdaq and S&P for instance. That’s how they can offer those terms,” he said.

“It wouldn’t be a big deal for us. Most of our clients are comfortable with those two indices.”

Risk reduction

Balcom conceded that the notes were not a good fit for bullish investors.

“If your cap is set at 30%, that’s an 8% annualized return. It’s not an aggressive return,” he said.

“If I look back over three-year rolling periods, my guess is that I’ll find a high likelihood of ending up in positive territory. The chances of losing more than 15% are probably very small.

“For some it makes sense to get a higher cap.”

But a growing number of investors do not anticipate high market returns after an 11-year bull market.

“The indices are at record highs. Many of our clients wouldn’t mind that kind of defensive strategy. If the market is up, you still get some decent gains. You’re capped but that’s what gives you the absolute return and the buffer.

“If your main goal is wealth preservation, it’s a good way of doing that,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Nov. 24 and settle on Nov. 30.

The Cusip number is 61771EKG2.

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