UBS’ $504,000 trigger phoenix autocalls on SPDR S&P Oil & Gas offer income play via sector bet

By Emma Trincal

New York, Sept. 12 – UBS AG, London Branch’s $504,000 of trigger phoenix autocallable optimization securities due Sept. 12, 2024 linked to the SPDR S&P Oil & Gas Exploration & Production ETF provide a pure income play for investors willing to get exposure to a volatile and changing sector, advisers said.

If the ETF closes at or above the trigger price – 60% of the initial share price – on a half yearly observation date, the issuer will pay a contingent coupon for that half year at the rate of 16.84%. Otherwise, no coupon will be paid that half year, according to a 424B2 filing with the Securities and Exchange Commission.

If the shares close at or above the initial price on a half yearly observation date, the notes will be called at par plus the contingent coupon.

If the notes are not called and the shares finish at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

Healthier sector

Scott Cramer, president of Cramer & Rauchegger, Inc., who is bullish on the ETF, said he liked the product for income.

“The bias is to the upside on oil and gas. But for somebody who wants income, it’s a great way to get it. The 60% barrier is particularly generous,” he said.

The underlying ETF provides exposure to oil and gas exploration and production stocks in the U.S. It includes large corporations such as Tellurian, Inc, Occidental Petroleum Corp., Exxon Mobil Corp. and ConocoPhillips.

“Oil & gas are cheap. They’re off their high of June by more than 25 points,” he said.

The share price closed at $145.20 on Monday. On June 8, the fund hit a 52-week high of $170.62.

The oil and gas industry has in many ways recovered from the bear market of March 2020, helped by a strong rebound in oil prices, he said. Crude oil is now trading at around $90 a barrel versus less than $20 in the spring of 2020 when the Covid-19 pandemic halted demand for energy worldwide.

Cramer pointed to the newly restored financial health of many oil and gas companies as an additional reason for being bullish on the sector.

“These companies’ balance sheets and debt structure are in much better shape than two years ago,” he said.

“Most have significantly reduced their debt. They have much more cash on their balance sheet. Many of them are doing buybacks. They’ve also increased dividends.”

A number of oil and gas producers went bankrupt because of the global slowdown induced by Covid-19.

But the industry has since displayed “a lot of capital discipline,” he said.

“Instead of spending like they did before, they’ve reduced their capex.

“This time they haven’t grown at the cost of their profitability.”

Bullish case

The structure of the notes offered a satisfying risk-adjusted return, he said.

“The 60% barrier is very defensive. And the coupon is attractive.

“Your upside is capped, but you’re buying this for income. You’re not buying it for growth.”

Betting on the ETF requires having a view on oil prices, which are an important contributor to the share value of the fund’s holdings.

Cramer said he was bullish on the commodity given the limited supply and growing demand worldwide.

While the ETF is still below its June high, its price has jumped about 35 points from a low in early July.

“It’s amazing how much it went up,” he said.

Cramer said it was unlikely that the underlying fund would drop more than 40% from its current level.

“Of course, the ETF is highly correlated to the commodity and declining oil prices are always the key risk,” he said.

“But my view is that oil prices are going to stay high.”

If the notes had priced today, the barrier level would be at $87, he noted.

Based on the assumption of a “one-to-one correlation” between oil and the underlying stock fund, oil prices would have to fall from $90 a barrel to $55 a share in order for noteholders to be at risk of a barrier breach.

“I don’t see oil falling that much. With all the supply constraints and rising world demand, I just don’t see it,” he said.

The inflation factor

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, without being necessarily bullish on the sector, saw in the notes a good “range bound” play for income investors.

“It’s an interesting one. I certainly don’t think commodity prices are all of a sudden going to go down in two years,” he said.

While the ETF was “pretty close to its peak,” he said the downside risk was limited by the barrier size.

Another risk mitigating factor was inflation.

“It looks like we’re going to be range bound for the next two years,” he said.

“Inflation will provide support for the commodity, he added.

Commodities tend to fare well in a rising price environment as they are often used as a hedge against inflation.

“Inflation is not going away. We are in an environment similar to the 1970s. Even if inflation goes lower, it’s going to come back,” he said.

“16% is an attractive yield in relation to the 60% barrier.

“The note seems to address a lot of needs for both income and protection.”

Another factor reducing the chances of capital loss at maturity was the autocall.

“At some point this note is going to get called away,” he said.

Given the coupon and the semiannual frequency for coupon payments and call observations, such outcome may be welcomed by investors.

“It’s a way to make extra money over a short period of time,” he said.

Regulatory headwinds

Carl Kunhardt, wealth adviser at Quest Capital Management, said he would not consider the notes.

“I’m fully exposed on the downside beyond a 40% decline and my return is capped at the coupon level,” he said.

Such risk-reward was not problematic in itself, he noted, as it is the way most income-oriented autocallable notes are designed.

For Kunhardt, the “problem” was the embedded investment theme, not the terms.

“I wouldn’t do it because it’s a sector play and it’s a play on a very volatile sector. This note is more of a speculative bet than an investment,” he said.

However, for an aggressive investor looking to “play the energy sector,” the note may offer some appeal, he said.

But the real risk perceived by Kunhardt was the “macroeconomic” environment along with the forces pushing toward energy transition.

“California just banned gas-powered vehicles starting in 2035. Our own transportation secretary [Pete] Buttigieg said last week that he was “really interested” in these kinds of measures.

“There’s an old saying on Wall Street: don’t fight the Fed. I would say don’t fight an administration that has demonstrated a strong bias against the oil industry.

“I think the current environment makes it very difficult to succeed in this sector as an investor. So why bother?” he said.

The inherent volatility of oil prices was another negative factor.

“I’m not sure that a 60% barrier is enough frankly. I mentioned the macroeconomic situation. But regardless of that, oil is extremely volatile. This ETF could drop more than 40% in a very short period of time.

“So, I’m not sure I would want to play that game,” he said.

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes settled on Monday.

The Cusip number is 90303X821.

The fee is 1.75%.

© 2015 Prospect News.
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