Credit Suisse’s absolute return notes show worst-of, buffer on two correlated oil stock funds

By Emma Trincal

New York, Aug. 16 – Credit Suisse AG, London Branch’s 0% absolute return buffered securities due Aug. 26, 2021 linked to the worse performing of the Energy Select Sector SPDR fund and the VanEck Vectors Oil Services exchange-traded fund show two unusual characteristics, sources noted.

First, the barrier, which prevails in most absolute return structures, is in this product replaced by a buffer.

Second, the return is tied to the lesser performing of two funds, a feature also relatively uncommon with absolute return notes.

Also significant: both funds show a high positive correlation, erasing some of the risk introduced by the worst-of.

Returns are tied to the lesser performing fund at maturity. The payout is par plus 1.5 times any gain up to a 45% cap, according to a 424B2 filing with the Securities and Exchange Commission. This cap is the equivalent of a 13.2% annualized compounded return.

If the lesser performing underlying falls by up to 15%, the payout will be par plus the absolute value of the return of the lesser performing underlying.

If the lesser performing underlying falls by more than 15%, investors will lose 1% for every 1% decline of the lesser performing underlying beyond 15%.

Shortage ahead

“This is for somebody who is bullish on the oil sector,” said Scott Cramer, president of Cramer & Rauchegger, Inc.

“I like this note because I happen to believe that we’re walking into a supply shortage over the next three years.”

Cramer believes that supply will fall short of demand in part because investments in the sector have declined as a result of oil prices falling since their peak in 2008.

Oil traded sideways from 2009 until 2014 when it suddenly dropped again. The commodity recovered in the spring of last year and has somewhat rallied this year as OPEC impose limits on supply.

Now Cramer said the lack of supply will drag prices down over the next cycle.

“Oil by 2020 will be in severe shortage. Oil fields naturally decline, and unless you drill new wells to replace oil, you’ll have a supply that will fail to match global demand,” he said.

“Some people believe that shale will increase production levels. But we can see it won’t be able to make up the difference.

The structure of the notes offered a good opportunity to express a bullish view, he said.

“The buffer will protect you. It’s good that it’s a buffer. Had it been a barrier I would have said ‘it’s terrible’. Oil is so volatile. There’s a bunch of geopolitical factors that can move the prices substantially. My outlook is bullish. With the conflict between Saudi Arabia and Yemen and the Iran sanctions, there will be plenty of opportunities for oil prices to go up,” he said.

High correlation

Another positive about the structure was the overlap between the two funds.

The VanEck Vectors Oil Services ETF seeks to replicate the performance of the MVIS U.S. Listed Oil Services 25 index, which tracks the U.S. companies involved in oil equipment, oil services or oil drilling. The fund’s top holdings are Schlumberger Ltd., Halliburton Co. and National Oilwell Varco Inc.

The Energy Select Sector SPDR ETF has a wider scope as it represents the energy sector in the S&P 500 index. Its top holdings are Exxon Mobil Corp., Chevron Corp. and Schlumberger.

“There is a lot of overlap. These two funds are highly correlated,” he said.

The 120-day coefficient of correlation is 0.91, which is high. Perfect correlation would be 1.

“Each time you have a worst-of, you want the underliers to be very correlated, not the opposite.”

Finally, the 45% cap was “decent,” he said.

“It’s a little low but you have the buffer that protects you and the absolute return.

“This note is a good bullish play.”

Nuclear disruption

Steve Doucette, financial adviser at Proctor Financial, liked the structure but not the underlying investment theme.

“The energy sector, especially oil, is so volatile. Who knows where it’s going? There are so many geopolitical variables that can play out one way or the opposite way. All of a sudden, the Saudis decide to open the floodgates.

“You’re making a bet and you’re wrong. It’s loaded.”

Doucette said oil is also a risky bet due to the emergence of alternative energies. Renewable energies even in the relatively short term are likely to compete with fossil fuels. But the future may reside in nuclear fusion, a new technology with unlimited potential, he said.

“Oil is very risky. Geopolitics, alternative energies or anything else can affect prices any time,” he said.

Good deal

Aside from the asset class, Doucette said he liked the terms of the notes.

“I always like to see buffers versus barriers because you can outperform on the downside. The absolute feature is good although you lose it if you bust through the buffer threshold. But at least you keep the cushion for your protection.

“There’s also a decent amount of return on the upside.

“Too bad I lack a strong conviction on oil because the structure of the notes looks pretty good,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on Aug. 23 and settle on Aug. 28.

The Cusip number is 22551L4H0.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.