Citi’s $1.84 million autocall pays high fixed rate thanks to uncorrelated, volatile stocks

By Emma Trincal

New York, Nov. 4 – Citigroup Global Markets Holdings Inc.’s $1.84 million of 13.7% autocallable equity-linked securities due May 9, 2022 tied to the common stocks of Microsoft Corp., Moderna, Inc. and Walt Disney Co. provide very competitive terms, including a fixed double-digit coupon rate and a low barrier, but the risk is commensurate with the compelling terms, said a market participant.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically redeemed at par plus the coupon if each stock closes at or above the applicable autocall barrier value on any monthly observation date after three months. The autocall barrier is 85% of the initial value for the first five observation dates, stepping down to 82.5% of the initial value for the next five observation dates and to 80% of the initial value for the last five dates.

The payout at maturity will be par unless any stock finishes below its final barrier value, 50% of its initial value, in which case investors will be fully exposed to the decline of the least-performing stock.

“A 13.7% coupon, guaranteed, is attractive. To get that, they used uncorrelated stocks,” the market participant said.

“It’s a good trade.”

Negative correlations

Two pairs of stocks showed negative correlations as measured by their one-year coefficients of correlation.

Moderna and Microsoft have a minus 0.1 coefficient of correlation. Moderna and Disney display a minus 0.16 correlation.

A correlation of plus 1 means both assets move exactly the same way. Inversely, a minus 1 coefficient means they move opposite, and 0 means no relation. The metrics is calculated on a scale of minus 1 to plus 1.

Worst-of structures use low correlations to extract more premium as the lower the correlation between the underlying assets, the greater the risk. However, correlations between worst-of underlying tend to remain positive albeit weak. Negative coefficients are less common.

With this note, only Disney and Microsoft are positively correlated with a 0.7 coefficient.

High volatility

“The 50% barrier is deep, which is good. But it’s also because these are volatile stocks, especially Moderna,” the market participant said.

Biotechnology company Moderna is one of the leading contenders for a Covid-19 vaccine. Its stock has an implied volatility of 88, which is twice as much as Walt Disney’s 41.

Microsoft’s implied volatility is the lowest of the three at 33.

“Any of these stocks could drop significantly,” he said.

“Disney +, their streaming service, looks pretty strong, and they’ve pushed for new content. Earlier this year people expected Disney to be Netflix challenger, but they didn’t get as much subscribers as anticipated,” he said.

The biggest headwinds for the entertainment global company come from the pandemic.

“If we see more parks and resorts close because of Covid, the stock could drop a lot,” he said.

For Microsoft, the risk lies in a trend reversal.

“It’s been up so much you could easily see a pullback,” he said.

The stock has gained nearly 40% so far this year.

“Microsoft could drop 15% or 18%. ... So, you may not get called.

“The most obvious tail risk is Moderna. If their vaccine fails, you could easily see a 50% decline,” he said.

Early redemption

The structure facilitates the occurrence of a call, which reduces the risk of losing principal at maturity while introducing reinvestment risk and interrupting the income stream.

“It’s a monthly call. They can price a higher coupon when the notes are likely to be called,” he said.

The autocall barrier stepping down from 85% to 82.5% and finally 80%, increased the odds of a call even further.

But such call features may not be to the liking of everyone.

“Your chances of being called out in three months are extremely high,” said an adviser.

“When it happens, you’ve got to start the whole process all over again. It’s my job to look for income opportunities for my clients and 13.7% fixed rate is certainly an amazing coupon. But those early calls make it harder to meet my investors’ need for income. There are only so many hours in a day.”

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes priced on Oct. 30 and will settle on Thursday.

The Cusip number is 17328WY93.

The fee is 2.85%.

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