UBS’ PLUS tied to SPDR S&P Oil & Gas Exploration & Production offer short-term bet on rebound

By Emma Trincal

New York., Dec. 21 – UBS AG, London Branch’s 0% Performance Leveraged Upside Securities due June 24, 2016 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund are designed for investors who expect a short-term rally in oil, sources said.

Investors need be confident in the timing of their bet as the downside is not protected. But the leverage offered on the upside allows them to enhance their returns should the bounce back be mild.

If the ETF’s return is positive, the payout at maturity will be par of $10 plus 200% of the ETF’s return, subject to a maximum return of 25.5%. Investors will be exposed to the losses if the ETF declines, according to a 424B2 filing with the Securities and Exchange Commission.

The underlying ETF, which trades on the NYSE Arca under the symbol “XOP,” tracks the performance of about 60 stocks of some of the largest U.S. oil and gas companies, such as Exxon Mobil Corp., Chevron Corp., Valero Energy Corp., Marathon Petroleum Corp. and Occidental Petroleum Corp.

The equity fund, whose performance is highly correlated to crude oil prices, is down 40% so far this year.

U.S. crude oil is in bear market territory, down 42% this year. Brent crude oil, the global benchmark, dropped to an 11-year low on Monday.

A ‘gamble’

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the trade is similar to a “gamble” even if betting on rising oil prices is not an irrational view given the magnitude of the sell-off.

The ETF closed Monday at $28.64. The 25.5% cap would represent a maximum price of $35.94, which was seen as recently as last month. But since then, the oil bear market has intensified, he said.

“Oil and gas is a mess. I don’t see the sector working itself out in the next year. It’s going to take multiple years,” he said.

“Look at what happened with the mining sector, both precious and industrial metals. Since the downturn began three to four years ago it has been down.

“You have signs that oil is following a similar pattern, at least as long as everyone continues to drill.

“I’m not all that positive on the sector at all.”

A rally is possible in the short term, he said, but he remains cautious.

“You could get a three or four months upside movement in the price from now,” he said.

“Right now it’s window-dressing time and tax-loss sell-off. That year-end trend tends to provide dislocation, and it’s not impossible that the market will normalize back.

“Some investors are beginning to think that the selling in oil is overdone.

“People always want to pick bottom, and when prices start to move up again you always get some short covering along with investors chasing the rally.

“So it’s not impossible to see a short-term rise in oil, and in that case, the trade makes sense.

“But it is a gamble. This note is a trade. It’s a six-month trade, not an investment.”

Chisholm said he would also avoid the notes because he does not feel comfortable with oil in general.

“Oil is a political commodity. I tend to stay away from it. While this note is about oil stocks, it’s still highly correlated to the commodity price. I have no control over drilling, no control over OPEC. So personally, I would stay away from that trade,” he said.

“Interest rates are going to move higher. That could strengthen the dollar further, which would not help oil.”

Oil prices are currently crashing, and a reverse could “take some time,” he said.

“Right now I don’t really see any sign of improvement unless these Middle East countries stop providing oil.”

Hitting cap unlikely

Peter Jankovskis, co-chief investment officer of OakBrook Investments, LLC, is also skeptical.

“It certainly is interesting,” he said about the notes.

The terms of the notes would match the view of a mildly bullish investor expecting limited downside risk and limited increase in price, he explained.

“I don’t see the likelihood that there will be a strong rally of energy shares because I don’t see crude itself rallying in that timeframe.

“Certainly, I don’t believe we’ll see much downside.

“So it’s an interesting offering in that respect.”

The risk of being “capped out” on the upside is not significant, in his view.

“You could see some people anticipating a rally in oil equity shares. If it happens, perhaps you could see a swing that might exceed that 25.5% cap for six months. You could conceivably have a rally of that size.

“But my guess is that it’s a low probability. You’d have to have a reason for the uptrend. I don’t see any such reasons right now.”

UBS Securities LLC is the agent. Distribution is through Morgan Stanley Smith Barney LLC.

The notes were scheduled to price Monday.

The Cusip number is 90275L284.

© 2015 Prospect News.
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