00:00:02 · Tracy Alloway, Joe Weisenthal, Alex Micalizzi, Tracy Alloway
[00:00:02] S0: Bloomberg Audio Studios. [00:00:04] S1: Podcasts. Radio. [00:00:06] S2: News. [00:00:18] S3: Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway. [00:00:22] S1: And I'm Joe Weisenthal. [00:00:23] S0: Joe, I'm going to warn you in advance. [00:00:25] S3: This is one of those episodes that's going to come with a lot of Greek letters, I think. [00:00:30] S1: I like these episodes. You know, it's funny. Some people, listeners, they'll tell us, they're like, you know, I love listening to Odd Lots. I have to admit, there are a few episodes I don't totally get what you're talking about. [00:00:41] S2: And I'll be like, I don't really get what we're talking about either. [00:00:44] S1: But I, you know, I aspire. [00:00:46] S0: But we like to aim high. [00:00:47] S1: Yeah, we like to aim high on this podcast. That's right. [00:00:50] S2: All right. [00:00:50] S3: Well, I think this is actually an important episode. We're going to be, I don't think we've ever devoted an entire episode just to this topic. We probably touched on it at various points in time. But today we're going to be talking. about structured notes. And I think this is important because we're used to talking about markets as these sort of fundamentally driven things. Like what's the bull case for AI? What's the bear case for AI? [00:01:13] S0: But there are all. [00:01:14] S3: These technical flows that also have an impact on markets. And I think we're in one of those moments right now.
00:01:14 · Tracy Alloway, Joe Weisenthal, Tracy Alloway
[00:01:14] S3: These technical flows that also have an impact on markets. And I think we're in one of those moments right now. [00:01:21] S1: No, totally. So I think a couple of things. First of all, you know, we are in this moment where like, look, anything AI related has been up an extraordinary amount. over the last few years. That's undisputable. And in fact, if you look at like expectations going over the next couple of years, all you see are various straight lines into the right. So revenues, capital expenditure, all of it, it all looks pretty good. But we are clearly in this moment of turbulence. If you just look at, say, certain aspects of the market, whether we're talking about some of the neoclouds, whether we're looking at credit default swaps, even credit default swaps on some of the really big companies are starting to inch out. I mean, I hadn't seen anyone post a chart of NVIDIA credit default swaps up until recently, but they're inching up just a little bit. There is clearly like, it's like the planes like rattling at high speeds here. And one of the ways that people have expressed bets on the AI trade is through structured notes, which, as you've mentioned, we've mentioned in various episodes, but I don't think we've really devoted an episode to them. [00:02:23] S3: Yeah, so this is one of the things when markets start to get kind of crazy, we tend to see more of these structured products sold. So, you know, people aren't satisfied with a 20% return in. [00:02:34] S0: An AI name. They want to get 40% yields.
00:02:34 · Tracy Alloway, Tracy Alloway, Alex Micalizzi
[00:02:34] S0: An AI name. They want to get 40% yields. [00:02:36] S3: Yeah. through a structured note on, I don't know, a core weave or something like that. And at the same time, there are also investors out there who start to get nervous at these valuations and they want to buy downside. And that's what some of these structured notes are doing. So today we do in fact have the perfect guest for all of this. [00:02:55] S0: We're going to be speaking. [00:02:56] S3: With Alex Micalizzi, he is a managing director and international head of equity structured notes over at Nomura. So Alex, thank you so much for coming on Odd Lots. [00:03:05] S2: And thank you so much for having me. [00:03:07] S3: Why don't we go ahead and start with a super basic question. How do we define a structured note or a structured product? My personal preference is I like to describe it as like a bank deposit or a bank IOU. I don't know if they like met a derivative and had a baby. This is what it would be. But I'm sure you have a different definition.
00:03:25 · Alex Micalizzi
[00:03:25] S2: I was thinking the same thing, actually. So yeah, you give me $ 100 or you give the issuer $ 100 and you're foregoing an interest rate. And in return, you take the issuer's credit risk. and they customize something related to the equity component. So there's two things there. Either we customize participation, the interest that you missed, we'll give you a call option, or we'll give you a call spread or a fancy name for a call spread is a digital, or we give you a bearish structure. You buy a put or a put spread or a put digital, something like that. Or the more common thing is yield. So you've got this forgone interest rate, this, and this extra credit, you can sell a put that premium. We then get that premium and give you a coupon. And that coupon, if it's really depends on how much you want to amp up that yield. And so we can do things with that, that make it take it away from, Hey, I could do this on the listed market by buying a put spread myself, and I could have the rest of the money in a bank account. We do stuff that enhances that yield. And generally that's in the, in the form of an auto callable. You can also mix and match. So there's a lot of bells and whistles here. You can combine yield with participation and all these things, depending on who's selling it, have different types of names, but in effect, those are the three components. We take your money. We either give you a participation, we give you a yield and it's through a combination of options. And an extra layer of that is we add certain things to make the put that you're selling more desirable to us. So you get a higher type of coupon.
00:05:08 · Joe Weisenthal
[00:05:08] S1: Fantastic. I always think, and I've mentioned a couple of times on the show that I love Emanuel Derman. We've had uses this analogy of the wall street bank as a kitchen and they give, they sell fruit salad. They buy a bunch of fruit in wholesale. apple. They buy a bunch of fruit in wholesale, but then they can chop it up in any different way possible to create any instrument that me, the customer wants. And then they sell it to me and then they charge a little margin. And because they're capable of chopping up the fruit in some way, any view that I want to express or any concern or any risk that I want to hedge with those raw ingredients, you can give me anything. Now, who is the natural buyer? Because if I'm interested in AI, I could buy SPY, I could buy QQQ, I could buy a memory ETF. If I'm nervous, I could sell whatever. Who are some of the natural buyers of structured products from the bank?
00:06:07 · Alex Micalizzi, Tracy Alloway, Tracy Alloway
[00:06:07] S2: Predominantly high net worth individuals through the private bank channels. I would say that why they want this is people understand a yield, right? And people understand what that means relative to owning a linear stock and the type of protection I can get. And so they can't, in a lot of ways, they can't structure this themselves. They can't go into the market. And we'll get into some of the more popular types of trades, which involve worst ofs and correlations and things like that and order callables. You can't physically do that in a listed market space. And so this product offers that ability to enhance yield that you just can't. get by selling, say, a particular stock downside. And with that comes, I think, what you initially said, some of the complications and some of the things that end up driving some of these market factors as well, because how we end up hedging this and the residual of what's left creates a very interesting dynamic that we're starting to see in the market. [00:07:08] S3: So you mentioned this particular moment in markets. Talk to us about what we're seeing in terms of issuance or what we have been seeing in terms of issuance. [00:07:16] S0: I'm used to thinking. [00:07:17] S3: about a lot of these things as single stock calls, right? So again, something that's tied to a core weave, and if the stock collapses by a certain amount before the note actually matures, then you either get all your money back with the interest or you lose out completely. But I know that we've seen a lot more index products as well.