Citigroup’s PLUS linked to Energy Select Sector SPDR priced for rebound but not for big rally

By Emma Trincal

New York, Jan. 19 – Citigroup Inc.’s 0% buffered Performance Leveraged Upside Securities due Feb. 1, 2019 linked to the Energy Select Sector SPDR fund offer an alternative to the index in a mildly bullish scenario with some slight protection, making the notes appropriate for a moderately bullish bet in the sector, sources said.

The payout at maturity will be par of $10 plus double any fund gain, up to a maximum return of at least 46.75% that will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will be exposed to any losses beyond 10%.

The underlying fund tracks the Energy Select Sector index, which replicates the stock performance of large oil and gas companies.

With oil prices trading 56% lower than at their most recent high in May, below $30 a barrel, this ETF is now at lows not seen since the financial crisis.

Tactical play

“Clearly this note represents a tactical/timing conviction on the bottoming of the energy sector,” said Dean Zayed, chief executive officer of Brookstone Capital Management.

“The question for the investor is, how much more downside is there?

“A real buffer helps here even though one would like it to be higher than 10%.

“I would buy this note as part of a growth allocation for a client. The cap is high enough, and the reward seems outsized compared to the risk given the recent sector performance.”

The right idea

Steven Foldes, vice-chairman of Evensky & Katz/Foldes Financial Wealth Management, said he likes the concept of a bullish bet on oil, but the risk-adjusted return of the product is insufficient in his view given the currently depressed valuation of the commodity.

“The idea of making an energy bet makes some sense. It’s probably not a bad idea at this point,” he said.

“Most analysts and strategists will tell you that for a one-, two- or three-year horizon, the current oil prices are not sustainable.

“I certainly don’t anticipate oil at $22 a barrel three years from now.

“So it’s the right idea. But a couple of things bother me about the notes.”

Fee, concentration

Cost was first.

“The 3% fee would have to come off. We’re fee-only. We don’t need the fee,” he said.

“I also don’t love the Energy Sector fund. It’s too heavily weighted towards two or three companies. Things may happen with these companies. It’s basically an Exxon-Chevron play.”

The top three stocks in the fund represent about 43% of the total. Those are Exxon Mobil Corp., Chevron Corp. and Schlumberger NV. Exxon and Chevron alone make for more than a third of the index.

Low cap

But Foldes’ main objection was the risk of missing some of the upside potential after oil recovers from the current bear market.

“While an energy note on oil has some validity at this point, this is a three-year product. That’s a substantial period of time. We don’t like investing in capped notes unless we can make at least 20% compounded annually,” he said.

The maximum annualized return on the notes is 13.65% on a compounded basis, based on the tenor, leverage factor and cap.

“If you think oil is going to go up substantially given its current price, this cap is too modest for a three-year,” he said.

“The 10% buffer is nice to have, but three years from now, how important is the buffer?

“I’d rather see a higher cap. Two times leverage is very nice, but this cap again is too low for us. The low cap is the biggest issue for us here.”

A second version

To make the structure more attractive, Foldes said a few terms would have to change.

“The buffer is not that important. We’re bullish on oil for this timeframe,” he said.

“I could reduce the leverage and even do away with the buffer if I could get the minimum 20% annualized we’re looking for. Then it would work.

“But it’s a long way from 13%.”

Citigroup Global Markets Inc. is the underwriter.

The notes (Cusip: 17323P389) are expected to price on Jan. 29 and settle three business days after pricing.

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