Credit Suisse’s knock-out notes tied to SPDR S&P Oil & Gas offer alternative to oil bet

By Emma Trincal

New York, Oct. 6 – Credit Suisse AG, London Branch’s 0% knock-out notes due Oct. 25, 2017 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund give investors with a range bound view on oil an opportunity to outperform the asset class over a short period of time, sources said.

A knock-out event will occur if the final share price is less than the initial share price by more than the knock-out buffer amount, which is expected to be 35%, according to an FWP filing with the Securities and Exchange Commission.

If a knock-out event has not occurred, the payout at maturity will be par plus the fixed payment percentage, which is expected to be 9.9%. If a knock-out event has occurred, investors will lose 1% for every 1% that the final share price is less than the initial share price.

The exact knock-out buffer amount and fixed payment percentage will be set at pricing.

The final share price will be the average of the index’s closing share prices on the five trading days ending Oct. 20, 2017.

“If the market keeps going flat or down but not down by more than 35% you can outperform in a nice way,” said Steve Doucette, financial adviser at Proctor Financial.

Market direction

The underlying fund tracks the oil & gas exploration and production space in the U.S. equity market. While not a commodity fund, its price is highly correlated to crude oil. The fund’s top holdings are independent exploration companies, such as Whiting Petroleum Corp., Oasis Petroleum Inc. and Anadarko Petroleum Corp., its three top components.

Oil prices have lost about 60% of their value from the summer of 2014 to their $40-a-barrel low in February this year. Since then the price has been trading in a range. An OPEC deal last week to cut oil output along with a government report released on Wednesday reporting that U.S. crude inventories have declined fueled a rally in the past few days, boosting oil price above $50 a barrel on Thursday, a four-month high.

Potential outperformer

“You are capped at 10% but 10% over one year isn’t bad. Theoretically you could outperform by 45%,” Doucette said.

The 35% contingent protection was attractive in that regard and offered “extra” protection.

“The average bear market is down 20%. So it gives you an extra 15% pullback.”

Sector risk

But Doucette fell short of saying he would consider the notes. As a rule, he is cautious about sector bets.

“Oil stocks have rebounded. But you have to know the sector. This note really works in a flattish, slightly down market. I would have to go back and do some due diligence and I’m not sure I want to do that,” he said.

“It’s kind of an interesting note, but I tend to stick to the big picture. We prefer the broad benchmarks. Once you get into sectors within the S&P you can get hugely different returns than the rest.”

The volatility in the energy sector and the fact that prices are directly influenced by macroeconomic and geopolitical factors, which require close monitoring, were drawbacks in his view.

“I’d rather take a correlation bet and buy a worst-of on the S&P and the Russell if I can get the same barrier. I would be much more comfortable with that,” he said.

Risk reward

“If you believe it’s going be even to down, it’s a good deal. You’ll capture that contingent protection plus the coupon,” he said.

But investors would need to know if they pursue a high-yield or an equity strategy. The issue of allocation then would have to be addressed.

“It is a nice coupon. But you risk being long the index. You’re capped at 10%. It’s an equity-like return.

“But is it a good fixed-income substitute? Are you not taking too much risk?”

His main objection however remained based on the nature of the underlying.

“It’s not the S&P. It’s a sector. You need to seriously take a look at this market before even putting any money in it. I don’t think we want to make those sector bets.”

Range bound

Matt Medeiros, president and chief executive officer of the Institute for Wealth Management, said he liked the notes based on current market prices.

“As we speak the fund is trading in a range right now even though the exploration component tends to fluctuate more than the price itself,” he said.

The ETF hit a 52-week high a year ago at 41 and bottomed in February down to 22. The share price, currently at 39, is 77% above the low and only less than 5% below the peak.

“As an investor you would need to be careful since we’re at the higher end of the range. But having a 10% return is appealing. Trying to get more would be too greedy, I think,” he said.

Sound protection

Seeing the barrier size as “reasonable,” especially if prices continue to move sideways, Medeiros said he would also be comfortable taking the downside risk.

“We see this index as pretty range bound. And even though it’s on the higher end of the range currently, the price seems stable enough to where it doesn’t appear that the range would pierce the barrier unless some information comes up from OPEC. But right now between 40 and 50 seems to be the range,” he said.

“So yes, it’s definitely an opportunity.”

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the agents.

The notes will price on Friday.

The Cusip number is 22548QKR5.

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