RBC’s autocalls on basket of two oil stocks tap into best-performing sector

By Emma Trincal

New York, April 13 – Royal Bank of Canada plans to price autocallable contingent coupon barrier notes due April 24, 2025 linked to an equally weighted basket of the stocks of Occidental Petroleum Corp. and Marathon Oil Corp., according to an FWP filing with the Securities and Exchange Commission.

The notes pay a quarterly contingent coupon at an annual rate of 10.5% to 11.5% if the basket is greater than or equal to its 60% coupon barrier on the relevant observation date. Coupon payments will include any previously unpaid coupons. The exact coupon rate will be set at pricing.

The notes will be automatically called at par plus the coupon payment if the basket closes at or above its initial price on any quarterly observation date after six months.

The payout at maturity will be par plus the coupon payment if the basket finishes at or above its 60% trigger price.

Otherwise, investors will be exposed to the decline in the basket price from its initial level.

Best sector

“I’m surprised you don’t see a higher coupon even if it’s an equally weighted basket given the volatility of those stocks. But I like the structure,” said a market participant.

“It gives you access to a very popular area of the market.”

As oil prices have soared, energy has become the top-performing sector this year, up 33.5% year to date. The Energy Select Sector SPDR fund, which tracks the performance of energy stocks, has gained 76% since its low point eight month ago. In one year, the share price of Marathon Oil has tripled while Occidental Petroleum has more than doubled.

As a result of those wide price fluctuations, the implied volatility of both stocks is high – 57.65% for Marathon Oil and 59.63% for Occidental Petroleum.

Up or down

“They’re both super volatile in part because they’ve been going through the roof. It’s not like they are beaten down,” the market participant said.

“Since they’re so high, I can certainly see them drop 40% from where they are now. If oil was to fall back to $80 a barrel, those energy shares would plummet.”

Oil price futures in the United States traded at $104 a barrel on Wednesday.

“At the same time, if oil continues to move up due to global constraints, those stocks could very well keep on rallying in a momentum move.

“Here’s my point: oil stocks can show sharp price moves either way. From my perspective, I would be looking at a coupon close to 15%, not 11%.”

Indicative pricing

The market participant admitted that the use of a basket rather than a worst-of for the underlying made the pricing of the structure more expensive.

“It eats up some of your return. The memory coupon I like a lot. And it’s costly too. Maybe you’re sacrificing 100 to 150 basis points. But at the very least you should get 12% or 12.5%,” he said.

The market participant priced notes individually tied to each stock.

“Indicative, for a three-year, 40% barrier protection, memory, I’m getting a 15% contingent yield for Marathon and a 16.75% for Occidental. That would be on a fee-based basis. Now I don’t have an indicative pricing for the basket. But it looks to me that 11% or even 11.5% is a bit low,” he said.

The fee is 2.25%, according to the RBC’s prospectus.

Inflation hedge

A buysider said the notes were timely given the surge in oil prices.

“It’s an interesting product,” he said.

“Everybody wants oil stocks right now. It’s an inflation hedge. We have more inflation due to logistic issues. First, it was supply and demand imbalances since Covid and now, the war in Ukraine made it worse. On top of that the Fed has been printing money and kept rates to zero for the longest time, falling behind the curve. We had those stimulus checks. There is myriad reasons why inflation is surging. In the meantime, oil prices are up, and those energy stocks are flying.”

Most of the terms except one were satisfactory, this market participant said.

Much too soon

“I like the memory coupon. I like the basket. I like the terms,” he said.

“But I’m not crazy about the six-month no-call. We don’t really like notes with call protections limited to three or six months because too often they get called that early. That’s good for the banks: they have an opportunity to charge a fee again. But it’s not necessarily good for the clients. This one is going to get called in six months. It will have to be rolled again.

“Other than that, it’s a decent note.”

This buysider said he usually doesn’t buy notes tied to stocks even if the exposure is to a basket of stocks.

“We like those weighted baskets, but we do them on equity indices. We see those baskets as a great way to build an allocation that fits into the portfolio, especially with growth notes. A note on the S&P, the EAFE and emerging markets for example would go right into the global equity sleeve.

“It’s much more convenient than any worst-of where you don’t really know where you’re investing in.”

RBC Capital Markets, LLC is the agent.

The notes will price on April 18 and settle on April 21.

The Cusip number is 78016FHK3.

© 2015 Prospect News.
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