Citigroup’s autocalls on Nasdaq, Russell offer equity replacement, unlimited upside potential

By Emma Trincal

New York, March 3 – Citigroup Global Markets Holdings Inc.’s 0% autocallable securities due April 1, 2024 linked to the worst of the Nasdaq-100 index and the Russell 2000 index give investors two potential payouts, both of which are a good fit for the equity bucket of a portfolio, said Marc Premselaar, senior managing director, structured solutions at CAIS.

The notes will be called at par plus 7.5% per annum if each index closes at or above its initial level on March 29, 2022 or March 27, 2023, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called and the lowest-performing index finishes above its initial value, the payout at maturity will be par plus 1.25 times the lowest-performing index’s gain.

If the lowest-performing index falls by up to 15%%, the payout will be par. Otherwise, investors will be exposed to any index decline beyond 15%.

Equity substitute

“The note gives you the possibility of participating in the upside at maturity. But you have a higher probability of getting called on year one or year two,” said Premselaar.

“If that’s the case, certainly, a 7.5% annualized premium can give you an equity-like return depending on your market assumption.

“If the market drops at maturity, you get this 15% downside buffer.”

He pointed to the benefits of the cumulative premium, distinguishing it from pure income.

A call at the end of the second year will yield a 15% premium, allowing investors to capture the total return even if a previous call has been missed, he explained. However, because investors only get paid upon the call, they are unable to collect any coupon while holding the notes.

“It’s an equity-oriented strategy. It can be a nice replacement for equity exposure because you’re not getting any income,” he said.

The upside is unlimited only if there is no call. If the notes are called, the premium will cap the upside.

“You just have to be willing to sell above 7.5%,” he said.

“These notes are good for the right client who understands the drawback and the benefit.

“As always, it depends on what your view of the market is.”

Big win, low odds

A market participant said the upside pricing at maturity was “optically attractive” because it merely reflected an unlikely outcome.

“It gives people a chance for an unlimited leveraged return, so on its face, it’s appealing,” he said.

“But if the notes mature, it means the market was down enough for you to miss two calls, one year after the other. In this scenario, your leverage is probably not going to come into play. It’s all about probabilities. You get this great upside – 1.25x, no cap – because the probabilities for the best setup at maturity are pretty low.

“That’s how pricing works.”

Path-dependent

For investors to capture the unlimited upside at a 1.25 rate in only three years, a certain sequence of events must happen, he added.

“Look at it that way: what are the odds that the market will be down after a year and then down again at the end of the second year to finish significantly higher after three years? If you can time it right, you don’t need structured products,” he said.

“What’s my probability of missing two calls in a row and then the market comes roaring back?”

Correlation

Another factor limiting the chances of capitalizing on the structure was the correlation between the two underlying indexes.

“The Nasdaq is tech-heavy, large-cap. The Russell is small cap with a modest exposure to tech,” he said.

More than 50% of the Russell-2000 index is allocated to health care, industrials and financials. Technology makes for only 13.7% of the portfolio versus 48% for the Nasdaq-100.

The three-year correlation between the Russell 2000 and the Nasdaq-100 is 0.787.

In comparison, the correlation between the two large-cap benchmarks – the S&P 500 index and the Dow Jones industrial average – is 0.98.

When the underliers are highly correlated with each other, investors incur less risk because the indexes will tend to move in the same direction at the same time and at similar magnitudes, which reduces the risk of dispersion.

“The Nasdaq and the Russell are not exactly strongly correlated. This is another reason why you get these terms at maturity. The chances of being able to leverage up a strong index performance after three years are not that great,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes will price on March 26 and settle on March 31.

The Cusip number is 17328YV76.

© 2015 Prospect News.
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