No kickout for UBS autocallable note but returns beat direct investment in the underlying

UBS sold an optimised autocallable structured note to US investors in February 2012 that has so far not kicked out but has paid back better than a direct investment in the underlying, the stock of Haliburton

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In April 2012, Structured Products analysed an autocallable note from UBS aimed at retail investors in the US. The note was linked to the performance of the common stock of Halliburton and offered annual returns of 13.34%, with the potential for early maturity if the value of the underlying asset was equal to or greater than its initial level on any of the observation dates. The final reading was set for February 21, 2013, one year after the strike date.

If the price of the underlying was equal to or above its initial value on the first observation date (three months into the product term), the product would terminate early and deliver a return of 3.335% plus initial capital. If the trigger level was not reached on the first kickout date and the product kicked out on the second observation date, investors would receive capital plus 6.67%. If the product continued to its third observation date, investors would receive a return of 10.005%. The final observation date offered a 13.34% return.

This type of investment is usually chosen by investors who expect low-to-moderate growth in the underlying, and appeals to those hoping to achieve a specified return in the event that asset performance is relatively flat. If the product is called, investors will achieve returns above the risk-free rate. As capital can be returned on any of the three observation points, the kickout feature reduces the possibility of capital loss compared with a fixed-maturity one-year product linked to the same underlying.

The value of the kickout depends on the fixed returns, their likelihood, and the downside risk if kickout does not occur. Investors in this type of structure need to consider the uncertainty around product maturity and reinvestment opportunities, but if the requirements are met they can benefit from an early return that is well above the risk-free rate.

The product featured a European barrier of 62%, which ignored movements in the underlying throughout the term and was observed only at maturity. The underlying could have fallen below the barrier at any time without placing principal at risk, but if it finished below 62% at maturity, investors would have lost capital at a rate of 1% for every 1% fall in the stock below the 100% level.

sp-0413-fvc-retro1

The chart shows that the price of the underlying did not meet kickout requirements but finished above its initial level on the final observation date, which means investors would have received their full capital at maturity plus a return of 13.34%. The final level of the underlying was 10.1% above its initial level. Therefore, excluding dividends, the product would have outperformed a direct holding in the underlying asset.

The chart also shows the one-year implied volatility over the term. As this is a capital-at-risk product, the volatility of the underlying had a large effect on the coupon. At the time of pricing, the implied volatility was roughly 32% - significantly higher than that of the S&P 500, which is a popular underlying for this type of product. The higher volatility means the product can offer a higher coupon than products linked to lower-volatility underlyings as there is a greater chance that the barrier will be breached at maturity. The barrier level and the coupon offered are dependent on each other and the volatility of the underlying. This product has a lower barrier than most products in this category, so even though it is linked to a relatively risky underlying, its risk profile is somewhat reduced.

Issuer: UBS
Country of Issue: US
Currency: dollar
Product Type: Autocall
Strike Date: February 21, 2012
Structured Products issue: April 2012

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