Citi’s $6.16 million bearish autocalls on Nasdaq present rally risk, but premium is tempting

By Emma Trincal

New York, March 28 – Citigroup Global Markets Holdings Inc.’s $6.16 million of 0% bearish autocallable securities due March 26, 2026 linked to the Nasdaq-100 index provide a tempting payout for bearish investors in which the odds of earning an attractive call premium seem high. But in the absence of a call, the outcome at maturity could be devastating for a portfolio especially in a market recovery scenario, advisers said.

The notes will be called automatically at par plus an annualized call premium of 30.25% if the index closes at or below its call level, 95% of initial level, on any monthly observation date after three months, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the final level of the index is less than or equal to its call level, the payout at maturity will be par plus 90.7499%.

If the index finishes above the call level but below 120% of its initial level, the payout will be par.

Otherwise, investors will lose 1% for every 1% increase of the index to a minimum payout of $0 per note.

Barrier

“The problem with this note is the potential for total loss if the index is up above the barrier. That’s the catch,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“I wouldn’t do this. It’s way too risky even if my market outlook tends to be bearish. You still have to manage your risk regardless of your expectations.”

Chisholm said he would have the same reluctance to buy a bullish note with a barrier.

“Whether it’s a barrier on the downside or on the upside, I’m not a fan of barriers. I like having limited risk. A barrier never really limits your risk,” he said.

“In this particular case, if the Fed cuts interest rates, the Nasdaq will go to the moon. Personally, I don’t think they will. But any sign of easing would take you well above the 20% barrier.”

Fed risk

Chisholm explained why he doubted the Federal Reserve would reverse course in its fight against inflation.

“I don’t think they’re going to cut rates. I don’t think that’s the direction they’re going to take. They’re not going to lower interest rates because they can’t. We still have high inflation,” he said.

“They can either lower interest rates and cause a bubble even worse than the one we had, or they can keep raising rates and take us to a recession to eliminate inflation. That’s what they said they would do since the beginning. They said they were going to create demand destruction.

“Nobody believes them. Yet they’ve been pretty clear.”

Managing risk

While the market theme embedded in the notes matched his personal convictions, Chisholm said the notes would not be an option for him.

“There are a lot of attractive things in this product,” he said.

“The yield is attractive.

“The 95% call strike is attractive. It’s very easy for the Nasdaq to be down 5%. That’s not my objection.

“My objection is that all the Fed has to do is cut interest rates and the index will fly well above 20%. In such case, you can go down to zero.

“I’m not comfortable with that,” he said. “I prefer buffers to barriers regardless of whether I agree with the macro-economic assumptions of a product.”

Already callable

Jonathan Tiemann, president of Tiemann Investment Advisors, said he was “intrigued” by the notes.

“This is really interesting. Obviously, this is absolutely a bearish note. But aside from that, I’m trying to figure out who would buy it,” he said.

The three-month call protection was necessary in this market, he noted.

In fact, the Nasdaq had already crossed the call threshold when it closed at 11,716.08 on Tuesday, or 6.42% off the initial level of 12,519.88 struck when the notes priced a week ago.

“You would have already been called in a week assuming there is no call protection or monthly observations,” he said.

Risk-reward

Tiemann said he was intrigued by the disparity of outcomes between two main scenarios: a) the call is triggered during the life and b) the notes are never called and the index breaches the 120% upside barrier at maturity causing investors to lose at least 20% and possibly up to 100% of their principal.

“Five percent is not a big drop so the call can happen very easily. If it does get called, you’re rewarded handsomely. If it’s not, you get killed if it’s above 20%,” he said.

The call premium was indeed very “rewarding” due to its cumulative nature but mostly due to its size.

Each month, the cumulative premium increases by 2.52%.

“Chances are you’ll be called, but each month that goes by increases the size of your gains significantly,” he said.

Against the odds

While tempting, the call premium earned in a down market was not a given.

“One concern is if the Nasdaq is up 10% for the first 12 months having never touched the 95% threshold.

“Now you’re more likely to be in a losing position,” he said.

Investors in the notes should have a view on volatility, he added.

“You don’t like vol. too much if you’re in this note. If there’s a strong upside with a lot of volatility, you can get really killed. If it drops too much, you get your money back too fast. You earn a nice premium but it’s too short.

“You’re sort of hoping that the market is going to go down slowly. I wonder if it’s very realistic,” he said.

While the premium was tempting, the risk of a positive return at maturity could be dissuasive for most.

“Investors tend to shy away from bearish bets. There’s a reason for that. Most of the time, the market is up, so statistically, it pays to be bullish. I would imagine that the chances for the index to finish above 20% are 50/50. That’s a big risk to take,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes settled on Friday.

The Cusip number is 17331HBM7.

The fee is 2%.

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