Societe Generale’s dual directional notes linked to oil index offer deep barrier, autocall

By Emma Trincal

New York, Feb. 11 – Societe Generale’s 0% autocallable contingent return capped dual direction knock-out buffered non-principal-protected notes due Feb. 27, 2020 linked to the S&P GSCI Crude Oil Index Excess Return give investors willing to get exposure to oil prices a chance to profit from a decline or increase in oil.

If the index closes at or above its initial level on any annual review date, the notes will be automatically called at par plus a call premium of 10% per year, according to a term sheet.

A knock-out event occurs if the final index level is less than the knock-out level, which is 55% of the initial level.

If the index return is zero or positive and a knock-out event has not occurred, the payout at maturity will par plus a 40% return.

If the index return is negative but a knock-out event has not occurred, the payout will be par plus the absolute value of the index return.

If a knock-out event has occurred, investors will be fully exposed to the index decline.

Bear market

With the S&P GSCI Crude Oil index down 56% from a year ago, the trade is not for everyone.

“We did some oil-linked notes earlier this year, but we stopped because oil just keeps on going down,” said an industry source.

“We don’t exactly know if we’ve hit the bottom at this point. Our clients are not eager to invest in oil, and we think it’s a bit too early to get back in this asset class.”

But the combination of the twin-win feature, a deep barrier and current market levels make for a timely investment for those with the risk tolerance necessary to invest in the commodity, argued a market participant.

Cumulative premium

“It’s a twin win to oil as an asset class,” this market participant said.

“When you buy anything it’s because you think it will go up, but you’re not guaranteed it’s going to go the way you want or take a loss. So you can do two things. Buy a principal-protected note and it will impair your upside, or get an absolute return note that allows you to participate in both the upside and the downside.”

The terms absolute return and twin win designate the same structure.

Another appealing feature is the “cumulative” coupon, he noted.

“If you miss a call, you don’t lose out. If you only get called on the second year, you’ll get your 20% profit,” he said.

Investors make their own assumptions on whether they expect the notes to be redeemed early or to mature. Either way, the upside offers a 10% annualized return, he said.

“There are different types of investors. There are some who want to get paid 10% after one year and go home. Others would say that getting 40% at the end isn’t bad either,” he said.

A different barrier

He compared the barrier used in a twin win with that used in most products.

“With a barrier all you do is get your money back. With a twin win, you make money. It’s not just getting your principal back. You can make as much in profit as the index declines.

“This one isn’t bad because you have a good buffer.”

He conceded that the pricing of the low barrier is partly the result of the high volatility of oil.

And yet the currently depressed prices make for an attractive entry point.

Entry price

“If oil was at $80, I would agree that it’s a bit tricky. But at $27 a barrel, with the 55% barrier, oil would have to drop to slightly less than $15 before you lose money,” he said.

The “worst-case scenario” according to most analysts is oil hitting $20 a barrel, he said.

“You’d have to go $5 below that. I’m not saying there is no risk. Any kind of investment involves risk.

“But personally, I like to buy on a big decline, and we already had a big decline.

“When I buy something I look at my upside potential, I look at the downside, I look at the risk reward. This one covers all these bases.”

Hedge for steepener exposure

Another possible benefit, he said, is to use the notes as a hedge for investors with exposure to steepeners.

He referred to the spread of the 30-year Constant Maturity Swap rate over the two-year CMS rate.

As the yield curve keeps on flattening, especially last week, bets on a steeper curve have suffered.

He pointed to a “high correlation” between the underlying oil index and the 30-year CMS minus two-year CMS spread. The yield curve tends to flatten as oil prices fall.

“If you own 30-2 CMS steepeners, it’s a good way to hedge against the flattening of the curve. You will make money from the oil note when the curve flattens, so you can use it as a hedge,” he said.

“If markets go the other way, you will still benefit from the upside in oil.”

SG Americas Securities, LLC is the placement agent.

The notes will price Feb. 24 and settle Feb. 29.

The Cusip number is 83369EFM7.

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