Barclays' capped notes tied to S&P GSCI Brent Crude target bulls, but volatility poses risk

By Emma Trincal

New York, Feb. 2 - Barclays Bank plc's upcoming 0% capped market plus notes due March 1, 2012 linked to the S&P GSCI Brent Crude Index Excess Return are designed for conservative investors who seek exposure to potential oil price gains with reduced risk.

However, the risk remains elevated given the high volatility of oil prices, especially in the current geopolitical context, sources said.

"It's a way for people to be long oil within a certain range," said Craig Pirrong, professor of finance at Bauer College of Business at the University of Houston.

"It will work best if oil trades in a range. In that case, it makes sense for investors looking for protection."

If the index closes below 80% of the initial level on any day during the life of the notes, the payout at maturity will be par plus the index return, which could be positive or negative, according to an FWP filing with the Securities and Exchange Commission.

Otherwise, the payout will be par plus the greater of the index return and 10%.

In each case, the payout will be subject to a maximum return of at least 24.25% that will be set at pricing.

Volatile underlying

"It looks like a risky bet given the volatility of oil," a market source said.

The Egyptian crisis and uncertainty around oil supplies have recently pushed up the price of crude oil futures. But oil prices are highly volatile and could easily move the other way around, sources said.

"Once you breach that barrier, you're basically long the price of oil," the source said.

"You would probably want maybe a greater downside protection or a greater contingent coupon than 10%, which is not bad. But to get that, you must never go down more than 20%."

Long oil

This source said that the product did not offer much value compared to a direct long position in oil because movements in oil prices have been so great.

"Either oil goes up a lot and you're better off being long the commodity," he said. "Or it falls a lot and you breach the 20% buffer, in which case you might as well be long oil."

The best-case scenario, he said, would be if oil was to trade range bound above the 80% barrier on the downside but below the 10% contingent protection. But he said that such outcome was "unlikely."

"There's very little chance that this product will outperform the index," he said.

"I don't think these notes give you a lot of extra juice against the market."

Volatility exposure

For Pirrong, the soundness of the deal depends on the underlying crude oil options.

"This is a relatively complex set of options. It looks like a collar," he said.

A collar is an options strategy in which the investor buys a put for the downside protection and pays for the put by selling calls, which operate like a cap. In this case, the strike price for the put would be 80% of the initial price and the call would have a 24.25% strike on the upside.

"I would be more interested in trying to figure out what your exposure to volatility is when you buy those notes," Pirrong said.

"The value of the embedded options will depend on the volatility of oil as you're both long and short some options.

"It would make sense to find out if the structure is volatility neutral or what the volatility skew is."

The notes (Cusip: 06738KAU5) are expected to price Feb. 4 and settle Feb. 11.

JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the agents.

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