Citi’s $11 million autocalls on Nasdaq-100 imply possible opportunity cost, volatility risk

By Emma Trincal

New York, Feb. 21 – Citigroup Global Markets Holdings Inc.’s $11 million of trigger autocallable notes due Feb. 18, 2026 tied to the Nasdaq-100 index could expose investors to the risk of not receiving any income as well as incurring losses at maturity because of a volatile underlying, advisers said.

After one year, the notes will be automatically called at par of $10 plus a call premium of 10.1% a year if the index closes at or above the initial level on any quarterly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the final index level is greater than or equal to the downside threshold, 70% of the initial level, the payout at maturity will be par.

Otherwise, investors will lose 1% for every 1% that the final index level is less than the initial level.

Cheaper pricing

The structure of the note is known as a snowball, which are autocallables providing payment upon the early redemption only. Snowballs differ from traditional autocallable contingent coupon notes, also known as “Phoenix,” in that payments are not coupons but call premia, which are cumulative. A higher threshold for payment needs to be met as the call occurs above initial price and not above barrier level as with a Phoenix autocall.

A market participant noted that snowballs tend to be structured on one underlier while Phoenix notes are usually built on several via a worst-of payout.

“I think it’s because snowballs for the issuer are cheaper to put together,” he said.

“With the snowball, once you’re called, it’s done. You don’t have to make future payments. That’s why issuers can do those things with just one index,” he said.

“The Phoenix on the other hand can pay coupons all the way. It’s more expensive to price. The issuer needs more juice. And so, investors typically end up with a worst-of.”

Income vs. premium

Some advisers seek snowball offerings because they like the fact that premia can be cumulated, he noted.

“If you miss one or several calls, you don’t lose anything. Phoenix autocalls don’t have that unless there’s a memory feature,” he said.

But some advisers may overlook the risk associated with snowballs.

“The problem is: what if it never gets called? At least with the Phoenix you get some income. With this you may end up with nothing at maturity.

“That’s why the Phoenix is more expensive to price. The issuer has to introduce more risk,” he said.

Julian Rubinstein, chief executive of American Asset Management, said investors use snowballs and Phoenix autocalls for different reasons.

“It’s growth versus income. Snowballs are growth vehicles. That’s what they are. Phoenix autocalls are designed for income. Growth should outperform income vehicles,” he said.

Volatile index

Rubinstein said he would not consider the notes given the volatility of the underlying index.

“A 70% barrier is not enough for me if I have exposure to the Nasdaq. We already went through the dot-com bubble. You go through that once, not twice,” he said.

Between March 2000 and October 2022, the Nasdaq lost about 80% of its value.

“There is not even a barrier level that would make me comfortable with the Nasdaq. It’s just too volatile,” he said.

65 years back

Despite its concentration in mega cap tech stocks, the S&P 500 index offered a much better alternative, he said.

Since 1957, there have only been three years in which the S&P dropped more than 20%, which are 1974, 2002 and 2008, he noted, citing a study from Allianz Investment Management. Out of those 65 years of data, only 11 years have seen the index fall by more than 10%.

Rubinstein said he would rather buy a conservative Phoenix autocallable note on three stocks than getting exposure to the Nasdaq.

“There are alternatives to get some attractive income with a much better risk-adjusted return,” he said.

Recently, he bought a Credit Agricole Phoenix autocall with a five-year maturity tied to the worst of Honeywell International Inc., Eli Lilly & Co. and Microsoft Corp. The coupon and final barriers were set at 50%; the quarterly contingent coupon was 9.8% per annum.

“I feel much more comfortable with this type of structure and terms,” he said.

Several scenarios

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said it was unclear whether the 70% barrier would be sufficient to prevent losses.

After a strong AI-driven rally last year the Nasdaq could go through a correction this year, he said.

If this scenario unfolded, the consequences on the call would be moot since there is a one-year no-call, he said.

On the second year, three “things” could happen: the notes could be called; mature at a loss; or at par with no gain.

“It’s anybody’s guess what may happen in the second year. AI has all the characteristics of momentum trading, so you could easily be called then.

“At the same time, investors may be concerned about the high P/Es of those tech stocks, and we may see a retracemen,” he said.

One likely scenario for this trader was if the Nasdaq-100 index finished negative but above the barrier.

“You get your money back and that’s it. No loss, no gain. This is actually not such a great outcome,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. and UBS Financial Services Inc. are the agents.

The notes settled on Friday.

The Cusip number is 17331N657.

The fee is 1.75%.

© 2015 Prospect News.
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