CIBC’s $6.85 million leveraged notes on commodity basket offer pure bullish play

By Emma Trincal

New York, July 7 – Canadian Imperial Bank of Commerce’s $6.85 million of 0% leveraged index return notes due Dec. 29, 2023 linked to an equally weighted basket of commodities provide a bullish exposure to commodities via a simple structure, sources said.

The basket components are the WTI Crude Oil Futures Contract, the copper spot price and the silver spot price, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.3725 times any basket gain.

Investors will be fully exposed to any basket decline.

Bull market

Commodities have rallied with inflation headlines as the asset class traditionally offers a hedge against rising prices.

The S&P GSCI index, one of the main commodities benchmarks has climbed more than 25% year to date, outperforming the S&P 500 index, which has gained 16%.

Structured notes on commodities remain scarce, however, amounting to less than 1% of total issuance sales, according to data compiled by Prospect News for the first half of this year. But their volume has more than doubled to $257 million from $116 million a year ago.

Investors bullish on commodities expect rising inflation and solid economic growth ahead, which recent inflation data has confirmed. Yet long-term Treasury yields have declined since April, which may signal that inflation may only be temporary as stated by the Federal Reserve or that the anticipated economic boom may still face some headwinds.

Risky

“Seems very speculative especially with the way commodities have been zooming up and zooming down,” a financial adviser said about the notes.

“They try to entice people who want to join the commodities rally bandwagon. Highly risky.”

Another financial adviser said he would not consider the notes due to the downside risk.

“Obviously, you’re bullish on commodities. You wouldn’t get unprotected exposure on a two-and-a-half year note if you weren’t.

“It’s definitely a play on the reopening, on the global economy getting strong,” the adviser said.

One of the three basket components however was more challenging than the others, he said.

“It’s hard to make a call on oil. It depends on so many factors, especially on what the OPEC does. You also have to figure out newer factors that are coming into play like renewable energy.

“I always prefer deals with some downside protection. I am on the cautious side,” he said.

No cap + leverage

The pricing of the notes however was attractive, sellsiders said, pointing to the absence of a cap and the 1.37 leverage multiple over a relatively short tenor.

“The leverage and the no-cap are good features,” a sellsider said.

“It suggests that the aggregate basket is in backwardation, meaning the forward is lower than the spot. That’s how you can buy the 1.37 times without having to use a cap.

“If the forward is at 90 and the spot at 100, you buy at 90 and sell at 100.”

Backwardation market

Long positions on commodities consist of rolling expiring futures contracts to maintain exposure while avoiding physical delivery. When current (spot) prices or shorter-dated contract prices are higher than longer-dated contracts, the negatively slopped futures curve is said to be on “backwardation.”

The backwarded curve has a positive impact on the long exposure by generating a “positive roll yield” upon the rolling of the contracts. As a contract expires, the sale at the spot price will be higher than the price at which the longer-dated delivery month must be purchased.

The structure was also relatively simple, relying mostly on long call positions for the leverage.

“They didn’t put any downside protection and they didn’t cap it,” he added.

“Doing those two things would require playing with another variable: volatility. They didn’t do that for the sake of simplicity. It’s a pure forward. You have a very simple structure designed for people who are bullish on commodities.”

Bullish bet

A structurer agreed.

“Some of the commodities offer good pricing. Copper for instance is backwardated. The forwards are cheap. The levered calls are cheaper,” he said.

If current contract prices are higher than future prices, as it is the case with backwardation, the cost of rolling the contracts at expiration generates a positive yield, which allows for better pricing, he explained.

“The forwards are cheaper because commodities have been in the news. They’ve been rising quite a lot. Currently the market expects the forwards to be lower than spot prices due to price’s tightness.”

“When you buy the notes, you’re betting against the forwards. You’re making a bet that prices will rise more than the forwards. This is how you can price this note relatively easily,” he said.

Three components

Both sources said the basket offered some level of diversification although far from the one provided by a commodities benchmark.

“You have crude oil and two metals. Silver is a precious metal while copper is more of a metal used in the industry,” the sellsider said.

“People know and understand those three commodities.”

“It’s a simple trade.”

The structurer agreed.

“It’s a diversified trade within the commodity space, one that’s easy to understand,” he said.

BofA Securities, Inc. is the agent.

The notes settled on July 1.

The Cusip number is 13607V721.

The fee is 2%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.