Citi’s $15.75 million buffered digitals on oil ETF monetize volatility for range bound trade

By Emma Trincal

New York, Oct. 30 – Citigroup Global Markets Holdings Inc.’s $15.75 million of 0% buffered notes due Nov. 20, 2024 tied to the SPDR S&P Oil & Gas Exploration & Production ETF give investors a chance to outperform the ETF both on the upside and on the downside. But the performance is limited to a range, which may prove to be too tight at a time when oil stocks and oil prices alike may turn increasingly volatile.

If the fund return is greater than 75% of its initial level, the payout at maturity will be par plus 12.8%.

Otherwise, investors will lose 1.3333% for each 1% decline beyond the 25% buffer.

Oil premium

The timing of the deal “makes sense,” said Ken Nuttall, chief investment officer at BlackDiamond Wealth Management.

“Oil has been going up like crazy in the last few weeks. Volatility has popped up. It’s risky. Oil by its nature is risky,” he said.

“The nearly 13% digital is a high return. It gives you a premium over what the indices offer, which is usually around 9%.”

He was referring to similar notes tied to several broadly diversified equity indices.

“You’re getting 4% more for this risk.

The notes allowed investors to express a view on oil over the next 13 months.

The war between Israel and Hamas may pose a risk to oil supply, he said, leading to higher prices.

“If you think oil is going to go up because of the war, it will definitely work.”

In-the-money

Crude oil prices went up sharply after the Hamas attacks on Israel on Oct. 7. But on Monday, futures prices sold off. Reasons were unclear. Some analysts argued that the market was more focused on the Federal Reserve’s meeting on Wednesday as well as the busy earnings stretch coming up this week.

Oil prices, however, remain volatile, he noted.

“You could get the 13% return in just a matter of weeks or days. Something that can go up so much and so quickly can also go down very fast. It’s good to have the 25% buffer. It’s even better to be able to receive the 13% payout if it’s down 25%,” he said.

“You get the 25% protection, and you still get your return,” he said.

Not for bulls

The note would not appeal to investors bullish on oil, he added.

Without being necessarily overly bullish, Nuttall said the digital posed a different kind of risk as it caps the upside.

“I personally would probably play it a little bit more bullish by buying the ETF directly and letting it ride.

“But the 25% buffer with a 13% booster is a pretty decent structure if you lack the conviction,” he said.

Broader market

And yet, the note would not land in his portfolio.

“It’s a bit too volatile for our clientele.

“With notes, we tend to use larger indices. It’s easier to explain why the S&P is down rather than why a random company in the XOP is down,” he said.

“XOP” is the ticker for the SPDR S&P Oil & Gas Exploration & Production ETF.

Nuttall said he owns the share of some energy companies in his portfolio. But he would not use energy stocks or an energy ETF as the underlying of a structured note.

Short volatility spikes

Another reason to avoid the security was timing, he added.

“Is oil a 13-month trade? Or is it a two- or three-month trade?

“Look, I don’t think this note is a horrible trade. But I wouldn’t do it on a one-year or a 13-month. Oil pops up and down very rapidly. When you’re playing oil, you’re playing volatility,” he said.

Limiting range

Dan Pickering, founder and chief investment officer of Pickering Energy Partners, said he expected price moves to be wider than the range offered in the structure.

“In a world where geopolitical and economic developments are as uncertain as they are, the odds that XOP would move more than 13% and more than 25% seem pretty high,” he said.

My qualitative assessment is that prices will either move significantly higher or significantly lower based on the war in the Middle East, the dynamics with China and the global economy.”

Magnifying stocks

The fact that the ETF consisted of stocks and not oil futures did little to reduce its volatility.

“The stocks of those oil companies tend to magnify the price of oil. They’re a levered play on the commodity. They are quite volatile,” he said.

He offered an example.

“Oil can go up 10% and an oil company’s profit can rise 50%. If oil is down 25%, profits could go down 100%.

“That’s the magnifying effect from my perspective,” he said.

“The folks who created these notes are super smart. I can see people using them as hedges.

“But I’m more inclined to take either the over or the under. I’d rather be either long or short, not in the middle.”

In conclusion he said he would rather be a seller, not a buyer of the notes.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter. Simon Markets LLC is a dealer.

The notes settled on Oct. 25.

The Cusip number is 17291QUB8.

The fee is 1.08%.

© 2015 Prospect News.
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