Bank of Montreal’s 14.4% autocallables tied to oil & gas ETF offer appeal in lower oil context

By Emma Trincal

New York, April 2 – Bank of Montreal’s 14.4% autocallable cash-settled notes due April 29, 2016 linked to the SPDR S&P Oil & Gas Exploration and Production exchange-traded fund are tied to a risky sector but may attract investors who believe that oil prices have already seen the worst decline, sources said.

In addition, the coupon appears attractive, they said, as it can be used as a cushion against losses.

The notes are autocallables on a monthly basis if the ETF closes above the call level, 110% of the initial share price, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called, the payout at maturity will be par unless the ETF finishes below the trigger price, 85% of the initial share price, in which case investors will be fully exposed to the ETF’s decline.

Interest will be payable monthly.

Decent upside

“Oil is very difficult to follow. Over the last year, this ETF and oil tracked pretty closely. The ETF, which is an equity fund, has shown less drastic moves, though. But they’re pretty correlated,” said Steve Doucette, financial adviser at Proctor Financial.

Doucette said the fixed coupon of 14.4% over a year is attractive and can be used defensively since it is guaranteed.

“You are getting 1.2% a month no matter what. That’s not bad,” he said.

“Even if oil toggles down a little bit, you still have this kind of built-in buffer with this coupon in addition to the barrier.

“If you’re comfortable with the underlying, it might be a reasonable way to capture a decent coupon.”

Barrier, cushion

On the downside, however, there is room for improvement, he said.

“What’s weird is that the first 15% is protected by the barrier but beyond that you lose the protection. If you breach it, you only have the 15% from your coupon. You can’t have both. If you breach the barrier, you’re only left with the coupon to buffer your losses,” he said.

“It would make more sense to have a buffer instead of a barrier. Of course you’d have to have less coupon.

“I would be curious to see what kind of coupon I would get with a 10% buffer instead of the 15% barrier.”

Higher call

Doucette noted that the autocall level of 110% is higher than the standard threshold, which is usually set at the initial price level.

“You need a 10% jump to get called. It’s such a volatile asset class, they’re expanding the boundaries,” he said.

“Instead of giving you a call at 100, it’s at 110. With that, they also give you more upside.

“Can you get called at this level? I wouldn’t rule it out.

“But the only thing you face then is reinvestment risk. You still collect your 1.2% for that month. That’s pretty good.”

But investing in this volatile underlying requires more research.

“It all comes back to doing your due diligence. I’d have to look into it more closely before showing it to a client,” he said.

Consolidation

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said current valuations in the oil market to which the ETF is correlated are an advantage for investors.

“Obviously the oil and gas industry has had substantial fluctuations over the past eight to 12 months. Currently, this sector continues to trade at a relatively low point,” he said.

“This particular underlying invests in small oil and gas exploration and production companies. Those players are particularly vulnerable to lower oil prices because low prices affect smaller companies more. They become candidates for acquisitions while crude prices are low in the context of the consolidation in this industry.”

Range bound

However, Medeiros said he does not expect oil and gas prices to rise substantially over the next 12 months.

“I don’t see a lot of movement in this particular sector other than some potential acquisitions,” he said.

“I think if I get more than 14% in this asset class in just one year, I would be very happy.

“Oil prices right now are sort of range bound. It’s a little bit on the lower end currently.

“On the upside, I don’t think we’re going to see a move above what we had eight months ago.

“On the downside, we could see further downward pressure. But I believe that we’ve already seen most of the downside.”

BMO Capital Markets Corp. is the agent.

The notes are expected to price April 27 and settle April 30.

The Cusip number is 06366RG25.

© 2015 Prospect News.
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