Either Goldman is desperate to raise $3.1 million (it's not), or the firm is offering investors a 300% leveraged surefire way to make money in a rising market via an investment in Leveraged Index-Linked (interest-free) Notes due 2011. Or, most likely, a third alternative - for others to profit, Goldman would have to lose, which is an amusing and quaint proposition (link to Goldman's 2009 profitable trading days here). The only way Goldman will not lose money on this issue is if the S&P closes below 1,123.7 on May 23, 2011 (the determination date). This has led some to question - is 1,123.7 a market ceiling according to this March 1, 2010 bond issue? To be sure, the notional is minor (however, more can always be tacked on), but someone's P&L, and thus bonus, will be determined on how these notes perform vis-a-vis Goldman, not investors.
The notes generate a return based on where the S&P closes on May 23, 2011: the higher, the better (if you are an investor). Investors are capped at a maximum payout of 118% of face, while their downside is unlimited (or 100%). The sweet spot is between the 100% and 118% return, where S&P returns are leveraged three fold, as can be seen on the chart below.
In essence the notes are synthetically equivalent to a covered call less the premium from selling calls. The benefit to Goldman - no need to be an options market maker on the ISE/CBOE, while in essence being an option market maker.
So what is the paydown to Goldman? The firm stands to lose the most if the market moves higher by 6%, after which it is indifferent for another 12% as max pain has been incurred, and furthermore its downside is capped.
Yet the only way Goldman makes money on this trade is if the market drips lower from the initial underlier level, or in this case, an S&P level of 1,123.7.
While in itself this trade is hardly substantial to make a bet on how Goldman is truly positioned in the market (as opposed to what its "strategists" Cohen and O'Neill would like you to believe), in combination with Goldman's recent major increase in SPY holdings, which implies the firm is net short underlyings (at least on the surface), one could make the case that Blankfein's firm sees the broader market substantially lower in one year.
We haven't gone through the risk factors yet. Those will likely be a hoot.