BMO’s $1.89 million leveraged autocall on S&P aimed at short-term bears, long-term bulls

By Emma Trincal

New York, Aug. 29 – Bank of Montreal’s $1.89 million of 0% autocallable market-linked securities due Aug. 24, 2026 linked to the S&P 500 index may appeal to investors expecting short-term volatility shifting into rally mode, advisers said. The notes, however, may not be suitable for bulls, they added.

The securities will be automatically called at par plus an 8.5% call premium if the index closes at or above its initial level on Aug. 23, 2024, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 150% of the gain in the index.

If the index falls by up to 25%, the payout will be par. Otherwise, investors will lose 1% for every 1% decline of the index from its initial level.

Early cap

The best scenario for investors is if the notes mature, said Jonathan Tiemann, president of Tiemann Investment Advisors.

“If at the end of the first year, the index is down a little bit, you are in a pretty good shape. The only way you can pay for this uncapped leveraged upside and downside protection at maturity is by taking a chance to give up the upside in the first year,” he said.

“I think it’s a fair tradeoff.

Even with a modest 8.5% call premium, investors can still outperform the index.

“If the market is up 1% and you get 8.5%, you wouldn’t be sorry. If it’s up 30%, that’s when you’d be sorry but at least you wouldn’t be in a losing position,” he said.

Scenarios

Most investors buying the notes are hoping to hold the notes for three years.

“You could get a pretty high return with this 1.5x leverage, and it’s kind of unlikely that you would be down more than 25% over a period of three years,” he said.

Even if the barrier was breached, noteholders would not be exposed to a greater risk than investors long the index, he added.

“This is really for someone who has a short-term negative view on the market, someone willing to sell the upside short-term in the hope of getting a good return over a longer period.

“If the market is down 5% in the first year and finishes up 40% point to point, I’m getting 60% in three years. That’s pretty darn good,” he said.

Tiemann said the notes did not carry a high level of risk.

“I think the 75% barrier is reasonable for that period of time. Different other scenarios could happen, but they are not necessarily negative,” he said.

Likely call

Another financial adviser said that the notes could appeal to moderately bullish investors.

“You want to be comfortable with an 8.5% return because the odds of getting this return in a year are pretty high,” he said.

Looking at statistics on the S&P over the past 70 years, he found that the likelihood of a call at the end of the first year was 73.6%.

“Your 8.5% is more than a CD, which would give you 5.5% at best. But it’s not guaranteed. However, you do have three out of four chances of getting it, which is quite a high probability.

“A roaring bull wouldn’t be happy with the call. But if you are more nuanced, it’s not a bad thing,” he said.

In fact, investors may be able to outperform the market even in the early redemption scenario.

The probabilities for the S&P 500 index to return between 0% and 8.5% in one year are as high as 19.2%, he said.

“You will outperform the market by virtue of this call one out of five times, which is very good.”

On the other hand, the chances of underperforming the S&P 500 after one year if the notes are called and the index return is greater than 8.5% are 54.4%.

“Again, if you are a raging bull, you’re not going to do this,” he said.

Barrier

Most investors would want to be able to hold the notes until maturity, he said, agreeing with Tiemann.

Such scenario is not impossible, he said, as no one can rule out a recession.

“The highly expected recession was supposed to happen last fall. It hasn’t. Then it was this spring. It hasn’t happened. Could it be this fall or next spring? There is a 27% chance that the market could be down over the next 12 months,” he said.

One caveat with the promising unlimited leveraged return at maturity, at least for conservative investors, was the barrier.

Running his back-testing data using three-year rolling periods, he found that investors were subject to a 4% chance of breaching the 25% contingent barrier.

“This makes me a bit nervous, but it’s still within my margin of error.”

This adviser has a rule: if the barrier breach risk exceeds 5%, he will avoid the note.

“I could live with 4%. If the barrier was 20%, the odds of breaching would rise to 6.4%. That would not be an option for me,” he said.

Timing the bear

The risk increases in relation to the severity and length of a bear market. For instance, a note pricing on Oct. 9, 2007 at the peak of the market would have been called in October 2008 after a 42% drop. Two years later, despite the beginning of a bull market in the spring of 2009, the three-year performance would have remained negative by more than 25%.

“The barrier would have been breached,” he said.

The Covid-induced bear market of March 2020 on the other hand may have allowed for record profits given the short length of the crash and the intensity of the recovery, he noted.

“It’s a note based on timing,” he said.

“The structure is a little complicated, but at least, they’re not cute about it. They don’t put a worst-of on four indices.

“The 8.5% is a bit weak. I would be cautious. If it was a 10% premium, I would give it an absolute thumbs up.”

For this adviser, equity exposure via structured notes should give investors a chance to earn double-digit returns.

“This is a note for someone who is pessimistic short-term and positive long-term. From that standpoint, maybe for you it makes sense to roll the dice.”

Wells Fargo Securities LLC is the agent.

The notes settled on Aug. 23.

The Cusip number is 06375M6T7.

The fee is 2.575%.

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