Bloomberg News

Sales of Structured Notes Tied to S&P 500 Fall With Volatility

April 11, 2013

Quarterly sales of U.S. structured notes tied to the Standard & Poor’s 500 Index fell to an almost two-year low as investors look to more volatile benchmarks for more attractive deals.

Banks sold $1.96 billion of securities linked to the gauge in the first three months of 2013 in 219 offerings, the slowest period since $1.69 billion of issuance during the second quarter of 2011, according to data compiled by Bloomberg. Volatility for the S&P 500, as measured by the Chicago Board Options Exchange Volatility Index, or the VIX (VIX), fell to 11.3, a six-year low, on March 14.

Investors are looking for notes tied to indexes where traders expect larger price swings in order to get better terms, said Dan Besse, managing director at Pacilio Wealth Management in Westport, Connecticut. Issuance of notes tied to the Russell 2000 Index (RTY), which tracks smaller companies than the S&P 500, surged 82 percent to $679.7 million in the first three months compared with the previous quarter, Bloomberg data show.

“I think if you’re buying structured notes when the VIX is at all-time lows and the S&P’s at all-time highs, that’s a tough time to be buying,” Besse said in a telephone interview.

The S&P 500 has climbed 11.3 percent this year to 1,587.7 yesterday.

Total sales of equity-linked notes climbed 25 percent last quarter to $7.31 billion from the previous period, Bloomberg data show.

Other Indexes

Notes tied to more volatile indexes have “higher return potential,” Besse said. His firm isn’t buying structured notes right now, he said, because of the effect of low volatility. When the measure declines, the value of options embedded in notes drops too, making it harder for issuers to create enticing terms on certain kinds of securities.

The Russell 2000 Index rose 11.4 percent this year to 946.09 yesterday. Its implied volatility, as measured using at- the-money options maturing in three months, was 15.8, about a third higher than that of the S&P 500.

Bank of America Corp (BAC:US). sold $62.4 million of three-year securities linked to the Russell 2000 Index, the largest offering tied to an equity benchmark other than the S&P 500 during the first quarter. The notes, issued Jan. 24, yield at least 30 percent as long as the index doesn’t fall below its initial value, according to a prospectus filed with the U.S. Securities and Exchange Commission.

The bank also issued $42 million of three-year notes tied to the S&P 500 on March 28. The two securities have an almost identical return, and terms are virtually the same, except the Russell 2000 note has a 5 percent cushion against losses and pays as much as 3 percentage points more when redeemed early.

Euro Stoxx 50

Matt Card, a spokesman for Bank of America, declined to comment on the notes.

Banks sold $761.4 million of notes tied to the Euro Stoxx 50 Index (SX5E) last quarter, more than twice the preceding period’s total. Expected price swings on the Euro Stoxx 50 Index, which has climbed 1 percent to 2,661 this year, are even higher than for the Russell 2000. At-the-money options imply future short- term volatility of 17.7, Bloomberg data show.

Movements in stock prices have been tamped down because the Federal Reserve buys $85 billion a month in Treasuries and mortgage-backed securities and is keeping its benchmark rate between zero and 0.25 percent for a fifth year, said Michael McCarty, managing partner at Differential Research LLC in New York.

“Big stocks have benefited from the actions by the Fed and the administration,” McCarty said in a telephone interview. “Volatility will rise when the Fed stops buying all these securities.”

Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

To contact the reporter on this story: Kevin Dugan in New York at kdugan4@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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