The Bank of Montreal/Ontario (BMO, Financial) has an interesting series of equity-linked notes. These notes are tied to the performance of various indexes and ETFs. The notes are essentially unsecured debt. As long as BMO stays in business, you will get your money back. My simple analysis says that BMO’s tangible equity to liabilities is 19.3 to 1. It has got some leverage in my opinion. S&P rates BMO’s debt as A+, but I never use the rating agencies in my final analysis.
The first note is tied to S&P Oil & Gas Exploration and Production ETF (XOP, Financial). The cusip is 06367TKA7 and matures on Sept. 29, 2017. If the ETF ranges between 70% and 110% of the initial value, the holder receives a monthly 8.4% coupon. If it rises above 110, you get called and make a 10% profit (plus what you made in coupons). If it falls below 70, you participate 100% in the losses.
The next one is based upon VanEck’s popular gold mining ETF (GDX, Financial). We hold this for clients but sold some off yesterday to lock in profits (the ETF on the equity-linked note). The cusip is 06367TKB5 and has the same maturity as the one above, Sept. 29, 2017. The coupon is 10.2% and the floor is 65. Why the higher coupon and lower floor? The options inside of the note are priced upon volatility. Gold miners are about as volatile as you can possibly get.
The next note is based upon the S&P 500 (SPX, Financial). Its cusip is 06367TKH2 and matures Oct. 31, 2017. This one used 125% leverage. The downside is only 5%, beyond that you lose. The S&P has to move 7.8% so your upside is $1,097.50 (take 7.8% times 1.25 for leverage). I am not so crazy about this one.
You can sell these notes prior to maturity. Personally, I would not do them. I might if the right circumstances arose. With the markets trading at an all-time high and gold doubling off its bottom, I am leery of the notes above. As for oil, I do not have the slightest idea where it is going to be trading next fall. I have also always been leery of investing in things that do not add actual economic value to society. If they were certificates of deposit and offered a true guaranteed floor, I would be very interested.
I would rather just own a little bit of the ETF I was bullish on in the industry. That is what we do with GDX. If were are wrong, we will just sell it. I do like BMO’s creativity. They are one of the best investment banks in commodities, due to the Canadian location.
Inside of these notes, you are taking on the risk that BMO stays in business, counter-party risk with the options, and of course the risk that the tracking ETF does what you want it to. Nevertheless, they are interesting investments to know about.
Disclosure: We own GDX.
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