Citigroup’s $6.7 million trigger PLUS on KraneShares CSI China Internet need more protection

By Emma Trincal

New York, Aug. 20 – Citigroup Global Markets Holdings Inc.’s $6.7 million of 0% trigger Performance Leveraged Upside Securities due Aug. 14, 2025 linked to the KraneShares CSI China Internet ETF provide exposure to a depressed and volatile underlying. But protection should have been prioritized over leverage in the current market cycle, said a contrarian portfolio manager.

If the final ETF level is greater than or equal to the initial ETF level, the payout at maturity will be par of $10 plus 150% of the ETF return, subject to a cap of par plus 90%, according to a 424B2 filing with the Securities and Exchange Commission. If the ETF declines by 20% or less, the payout will be par. If the ETF declines by more than 20%, investors will lose 1% for every 1% that the ETF declines from its initial level.

Panic in China

“Everybody has heard of this ETF recently. It’s been in the news a lot. The headlines have been very negative because of the Chinese government crackdown on tech companies,” said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

The share price plummeted as a result. It closed at $44.09 on Friday, 58% off its 52-week high of February.

The notes priced earlier on Aug. 11 at the closing level of $50.77.

For a contrarian like Kaplan, negative coverage can be good news.

“The headlines have created some kind of panic, which may push the stock price even lower.

“If you want to buy the stock, you could buy more of it incrementally as the price is going down.”

Kaplan said he did just that with this ETF, putting laddered orders to buy at incrementally lower prices.

Down even more

“The problem with notes is you don’t have this flexibility. You buy in a lump sum, and you’re locked in for four years at your initial price. The fluctuations don’t really help you. In this case, you’re really not taking advantage of the recent big drop,” he said.

“The only thing that helps you is the fact that the price was depressed on the trade date.

However, the ETF is now even more “depressed,” as it is trading 13.3% lower than initial price.

“It’s not quite as good. The note struck at a higher price. Right now, you don’t have a 20% barrier. You only have a 7% barrier,” he said.

Some of the benefits

Two elements in the structure were more compelling. One was the four-year term, which theoretically can give the ETF the opportunity to recover in a sell-off although it would depend on the magnitude of the price decline, he said.

The other was the maximum return offered.

“The 90% cap is good. If the stock goes up 60% in four years, you get 90%.

But the portfolio manager said he would be more concerned about the downside market risk.

Diverging markets

“The U.S. is in a bubble. Chinese stocks are not in a bubble. They’re very close to their fair value. So, they’re less at risk,” he said.

However, the burst of the U.S. bubble will have an impact worldwide, he predicted.

“If Chinese stocks now look cheap it’s because they were so expensive before losing 60% of their value. But it’s also relative. They look like a bargain because they’re not as overvalued as the U.S.”

The disconnect in valuations between the two markets should be a concern for investors, he added.

“At some point, either the U.S. is going down a lot, or China is going up.

“My guess is that the U.S. is going to go down a lot.

“In its core, the ETF eliminates the risk of overvaluation. But it doesn’t eliminate the market risk and by that, I mean, the contagion effect of a U.S. bear market on the rest of the world,” he said.

U.S. bubble bursting

Possible triggers for a bear market abound from the spread of the Delta variant slowing down the global economy to inflation or geopolitical tensions. But investors are mainly concerned about a change in the Federal Reserve’s easing stance and for good reasons, he noted.

“The market was very volatile this week, in part because [St. Louis Federal Reserve Bank president James] Bullard and other Fed members are beginning to push for tapering. It’s not yet factored in the pricing,” he said.

“More people at the Fed are starting to think that monetary easing has gone too far. Raising interest rates would be hard, so many recommend cutting back the monthly bond purchases.”

Losses, opportunity cost

What would initially be the burst of the U.S. bubble could rapidly evolve into a global bear market.

“I think the chance of going below the barrier is extremely high, even on a four year because we’ll see stock markets collapsing on a global scale,” he said.

Major bear markets lasting long enough to inflict serious damages have been seen before.

For instance, between March 10, 2000 and Oct. 10 2002, the Nasdaq Composite lost 78.4% of its value.

“When the U.S. stock market drops, things follow really fast everywhere in the world. People sell all kinds of things. They’re in panic mode,” he said.

Even if the four-year duration was to help the ETF stay above barrier level by allowing enough time for global markets to rebound from a bear market, investors would still incur some “opportunity risk,” he said.

“If it’s down by less than 20%, you get your money back at maturity but then you haven’t made any money in four years. That’s not a very good outcome. Better than losing money but you’ve wasted time and missed better trade opportunities.”

Highly volatile

Perhaps the most important element to take into consideration when examining the leveraged structure of the notes was the “extremely high” volatility of the underlying.

The KraneShares CSI China Internet ETF has an implied volatility of 58.23% versus 21.4% for the Nasdaq.

Kaplan said that the structure was simply not defensive enough in light of the volatility of the underlying and at the current stage of the market cycle.

Playing defense

“If more than half of your barrier is gone on the week following pricing, it certainly makes more sense to strengthen the downside protection, he said.

“I can see what investors are trying to do. They’re looking at the trade-off between the leverage and the barrier.”

In doing so, they may underestimate the need for downside protection, he noted.

“Maybe a bigger barrier, something close to 40% with less leverage would be more appropriate,” he said.

Leverage in question

For the leverage to be useful, the ETF would have to generate moderate gains at the end. Such scenario is less likely to occur with a volatile asset, which can move up and down significantly over time, he noted.

“A 40% barrier with a higher cap and no leverage would seem more attractive to me.”

“Why turbo charge a racing car that goes 200 miles an hour? It doesn’t make sense. Instead, you need the parts that will protect you against an accident.

“Leverage should not be a feature of notes tied to very volatile assets.

“Leveraging a treasury fund makes sense. Leveraging Chinese internet stocks doesn’t,” he said.

The notes are guaranteed by Citigroup, Inc.

Citigroup Global Markets Inc. is the underwriter. Morgan Stanley Wealth Management is a dealer.

The notes (Cusip: 17329L259) settled on Aug. 16.

The fee is 3%.

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