Citi’s $12 million buffer notes on S&P show accelerated absolute return via geared buffer

By Emma Trincal

New York, Nov. 29 – Citigroup Global Markets Holdings Inc.’s $12 million of 0% dual directional buffer securities due Nov. 29, 2024 linked to the S&P 500 index offer an original feature – leveraging the absolute return gains, applying the same leverage factor on the upside and downside, sources noted.

If the index gains, the payout will be par plus 125% of the index return subject to a maximum return of par plus 22%, according to a 424B2 filing with the Securities and Exchange Commission.

The payout will be par plus 1.25 times the absolute value of the index return if the index declines but ends at or above the 80% buffer level.

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

“Not seen that before or if I have, it’s very rare,” a trader said.

“I think it’s very attractive. You’re going to have a lot of interest in catching absolute return leverage on the downside.”

The two-year tenor was also a positive, he added.

“People have a more optimistic view over the medium-term. I can see the interest for a two-year.”

Give and take

A structurer said there was no “magic” behind the feature.

“It’s levered inside the buffer. I can’t say I’ve seen this before. But from a technology standpoint, there is no magic behind it,” he said.

“As always, you get to price those features using the resources you get from foregone opportunities.”

Those, he said, included getting paid only when the underlying trades within a -20% to +22% range.

“You’re capped on the upside. You can still lose 80% of your principal. You’re limited to a band. In this case, the band is split rather equally between the two sides of the trade,” he said.

Spreads

He explained how the issuer had created the product, using several options “legs.”

On the upside, you’re buying a call spread. You buy a 100% strike call (at-the-money) and you sell an out-of-the-money call at a 117.6% strike.”

The 17.6% return is the cap. With the 1.25 upside leverage, investors receive the maximum return of 22%, he explained.

For the downside, he also took into consideration the 1.25 gearing, placing the strike at 84%. A price decline of 16% brings the gain up to the 20% maximum level, he said.

“You’re doing a put spread. It gives you the protection and the inverse return inside the buffer.”

Knock-out put

A market participant was also intrigued by the notes.

“I’ve seen downside participation of 50% but not anything above 100%. That’s going to be expensive,” he said.

He offered an explanation about the downside structure.

“You’re long an at-the-money knock-out put with an 80 strike. Once the put knocks out at 80, the option is worthless. You’re no longer protected,” he said.

“You’re also short an 80 strike out-of-the-money put. Below 80, you start to lose money.”

But what surprised this market participant was the 2.35% fee of the product, as disclosed in the prospectus.

Cost matters

“The $23 fee is high. Usually, I do $3 to $5.

“I don’t have anything bad to say about this note. My only complaint would be the fee, which is outrageously high but other than that it’s a great note.”

This market participant said he asked Citigroup to reprice the notes based on his own fees. The bank came back with a 24.8% upside cap for the same terms. With a geared buffer, the cap could jump to 28.1%, he said.

This second version maintained the 1.25 gearing within the buffer, which accelerates the absolute return.

But it also accelerated the losses beyond the buffer by a factor of 1.25x leading potentially to full principal loss, a risk factor allowing for the higher cap.

Regardless of the scenario, the repricing with a lower fee gave a much higher cap than the original version, he noted.

“You can definitely raise the cap quite a lot. And that makes sense. The fees are reducing the amount of premium you can extract from writing those options. The higher the fees, the lower the cap.”

For advisers involved in managing clients’ expectations, especially bullish ones, the notes may present another downside.

“If we’re in a bull market, the 22% cap, which is about 11% annualized may not be very exciting for investors,” he said.

“People sometimes get upset. Say we have a big rally next year. The S&P is up 20%. Clients would look at their statements and say. This note is terrible!

“But I disagree. I think it’s a great note.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes settled on Tuesday.

The Cusip number is 17330YD72.

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