Barclays' notes linked to basket of commodities, index offer uncapped, leveraged bullish trade

By Emma Trincal

New York, Dec. 20 - Barclays Bank plc's 0% notes due Dec. 26, 2014 linked to a commodity basket are designed for cautious investors who want to play a commodity rebound with no upside limitation, sources said. The timing may also be appropriate, they said, due to the current commodity sell-off.

"It's a pretty reasonable deal," said Lee Kramer, president of Capital Management Analytics.

"Commodity prices have pulled back a lot recently with concerns about the European debt crisis and China slowing down.

"If you think the market will rally but still want to play it safe, this is a way to do it."

The basket includes Brent crude oil with a 35% weight, West Texas Intermediate crude oil with a 15% weight, copper with a 12.5% weight, gold with a 12.5% weight, corn with a 3% weight and the S&P GSCI Grains Index Excess Return with a 22% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.33 times any basket gain. Investors will receive par if the basket falls by up to 30% and will be fully exposed to the decline from the initial level if the basket falls by more than 30%.

Support

Kramer said that he is bullish on commodities because he believe that the Chinese government will start to ease monetary policy. In addition, commodity prices have already undergone a correction, giving investors in the notes a good entry point.

"I like the timing a lot. You have a good support with a 30% cushion on the downside and no cap on the upside," Kramer said.

"It's kind of a binary test: If Europe doesn't fall apart, commodities prices could rebound considerably. The fact that there is no cap allows you to benefit from this. The flip side is that if Europe blows up, then demand for commodities would fall and prices would drop."

Investors incur the risk of substantial losses, he said. But the chances of this scenario occurring are in his opinion limited.

One factor reducing risk significantly is the 70% barrier level, giving investors a soft protection of 30%.

Another factor is current valuations. Kramer compared the sector allocation of the underlying basket - 50% in energy, 25% in metals and 25% in agriculture - with that of the PowerShares DB Commodity Index Tracking fund, an exchange-trade fund. He concluded that the notes and the ETF show a "high correlation."

"DBC would have to drop 30% today to take you down to the lows of 2009, and that would be the support. So I think that the probability of breaching the 30% knock-out is pretty low. If it happens, you could be subject to very larges losses. But it's unlikely," he said.

"DBC" is the NYSE Arca ticker symbol for the PowerShares DB Commodity ETF.

Unlimited upside

For bulls, the notes offer the benefit of delivering leverage with no limitation on the upside.

"I really like that there's no cap," Kramer said.

Structuring a note with no cap but with leverage and downside protection poses pricing challenges, he said. In this case, the implied volatility of the basket, which he hypothetically compared with that of the ETF, may have helped.

"The implied volatility on DBC has stayed in a range around 24-26 since September. On the other hand, historical volatility for this ETF has been steadily declining, peaking at 26 mid-October, and it's today at around 19," he said.

"The puts are expensive, with the implied still high, so you can still bring in some good premium.

"It's favorable for options sellers. That's probably what allowed them to give some leverage without having to cap the upside.

Overweight oil

Matthew Bradbard, president of commodity brokerage firm MB Wealth, said that he likes the structure and the bullish outlook of the notes but not so much the basket composition.

"No cap. I like that," he said.

"The only thing I don't really like is this 50% allocation to energy. It's oil only. The WTI and Brent usually move in the same direction. You don't have heating oil, gasoline or natural gas.

"I like the agriculture component. Agriculture, in particular grains, will surprise a lot of people with China importing grains massively.

"The 30% is a pretty good cushion, especially on a three-year. Commodities move up and down, but I'm pretty sure that three years from now, prices will be higher than today."

Barclays Capital Inc. is the agent.

The notes (Cusip: 06738KE31) were expected to price Tuesday and settle Friday.

© 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.