Citigroup’s enhanced buffered digital notes on S&P 500 provide mostly bearish bet

By Emma Trincal

New York, May 26 – Citigroup Global Markets Holdings Inc.’s $500,000 of 0% enhanced buffered digital securities due Aug. 25, 2021 linked to the S&P 500 index give cautious investors a way to hedge their portfolio without committing to a bearish view. The notes are seen as a non-directional product with a moderately bearish tilt, advisers said.

If the final level of the index is greater than or equal to its final buffer value, 80% of its initial level, the payout at maturity will be par plus the digital return amount, or 6.2%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will lose 1% for every 1% that the index declines beyond 20%.

For uncertain times

“I think for bearish investors or those who are not overly optimistic about the market going up in the next 15 months, this is a reasonable play,” said Kirk Chisholm, wealth management and principal at Innovative Advisory Group.

“It can be used if you want exposure to the S&P. You’re not going to lose money if the market is up. But you can benefit even more from a pullback. There are not so many opportunities making people feel comfortable right now given what’s going on.”

“The market is where it was in October. Meanwhile, 20 million people lost their jobs last month. That the market somewhat in the next 15 months is going to be higher, I find hard to imagine.”

The notes would strongly favor a bearish view.

“If the market is down 20% you get this 6% return. That’s a reasonable way to hedge.”

Should the index turn out to be positive at maturity, however, the notes would not penalize investors unlike other bearish structures.

“If you’re going to have some upside, at least you get 6%. I’m OK with that,” he said.

Other bear plays

Investors uncertain about the direction of the market over the near future have different options if they want to hedge their long exposure., sources said.

A typical directional instrument is the bear note, which provides gains in a down market but losses in a rally. Other versions of the bear notes bring full principal protection against the risk of a bull market, allowing bears to bet with confidence on a market decline. However, such products have no or cash-like, limited returns if the market is up.

At least the Citi notes give a 6% return to bears who would happen to be wrong, he said.

“The challenge is if the market drops more than 20%, which is always a possibility in my opinion. But at least you have the buffer and you will limit your losses.

“So, I think this note is a decent way to express a bearish view on the market.”

Other structures available to investors seeking to express cautious views are dual directional notes, which provide one-to-one gains in both directions but in a limited way. The gains on the downside are “capped” most of the time by a barrier, which when breached generates a drastic change in the outcome. For instance, an 80% barrier could transform a 20% gain into a 20.01% loss by one basis points of index decline. The upside is almost always capped.

Bearish bias

This note, said Jonathan Tiemann, president of Tiemann Investment Advisors, is different in that it is more directional given the digital payout. No matter how much the index moves above the minus 20% threshold, the digital amount will be the same: 6.2% over 15 months, or less than 5% on an annualized basis.

“It’s a bearish note on the S&P, no question about it,” he said.

“You will earn more if the index is negative. You outperform the most on the downside.”

The notes may be used in a tax strategy, he added.

“If you’re long the index and don’t want to realize capital gains for tax reasons, then this might help you hedge your portfolio of equities.”

In-the-money digital

Traders sometimes call the Citigroup note an “in-the-money” digital. That’s because the strike price of the equivalent of a long call position is placed below, not at the initial price or “at-the-money” price.

This form of payout provides a “boost” or a “jump” as soon as the index is at or above the strike price.

Compared to most absolute return products, which tend to lack any return enhancement on the upside, this type of digital payout can outperform in a slightly positive market. But Tiemann said the note is tilted toward the downside because it will outperform mostly when the index falls given the wide, 20-points range between the buffer and the initial price.

“You can outperform on the upside too, but the market would have to be sort of flat. This is definitely geared toward bearish investors,” he said.

Buy-write

“It’s basically a simple buy-write strategy. You’re long the index and you write a call option, which will pay you a premium and limit your upside.”

In this case, the strike price of the short call option is at the digital level, or 6.2%.

“I sort of like it even though it wouldn’t fit into the way I invest.

“But another person willing to bear some market risk without taking on the full risk might find it interesting as a hedge.

“After all, who knows where the market will be in 15 months? I have no idea,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes settled on Tuesday.

The Cusip is 17328VQD5.

The fee is 0.6%.

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