Citi’s $42.29 million bearish buffer GEARS on S&P show unusually big size, competitive pricing

By Emma Trincal

New York, April 19 – Citigroup Global Markets Holdings Inc.’s $42.29 million of 0% bearish capped buffer GEARS due Jan. 17, 2024 linked inversely to the S&P 500 index intrigued market participants for the size of the deal and the relatively attractive terms compared to the common bullish version of the same product type.

If the index declines, investors will gain 3% for every 1% decline of the index, subject to a maximum return of par plus 24.84%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes flat or gains by no more than 8%, the payout will be par.

Otherwise, investors will lose 1% for each 1% gain of the index above the 108% threshold level, with losses capped at 92%.

Big deal

“I haven’t seen a bear note that big before, and I’ve priced a number of them, especially shark notes. This one is pretty interesting. Leveraged capped with a buffer just like a regular bullish note,” said a structurer.

With a shark note, investors earn a “rebate,” which is a premium or “bonus” once the barrier is breached. The problem with the rebate is that it “knocks out” the participation unlike a cap, which merely puts a limit to it.

Shark notes are often used for the structuring of bear notes.

“This note is some kind of loss mitigation product. You neutralize your portfolio by investing in something that hedges your position to the downside,” he said.

“You’re selling options plus you’re using the 1.25% worth of dividends to finance your 3x leverage.”

The S&P 500 index has a dividend yield of 1.67%, which over a nine-month period is approximately 1.25%.

Put spread

The gains on the downside are achieved through a “put spread,” he explained.

With the maximum return set at 24.84%, the actual cap would need to be at 8.28% based on the 3x leveraged exposure.

The structure consists of buying three 100 strike puts (or “at-the-money” puts) and selling three out-of-the-money puts at a strike of 91.72%.

The 91.72 puts are “out-of-the-money” because the strike is below the current price of 100.

On the other side of the bearish trade, the 8% buffer, which cushions against losses when the index rises above 8%, is obtained by selling a call at 108%.

Bear vs. bull pricing

What this structurer found interesting was how well the note priced compared to comparable structures but geared to gain from market uptrends.

“I don’t think I could replicate the same terms with the bullish version of this...not on the S&P,” he said.

“I would get a much lower cap on a nine-month given the volatility on the S&P puts right now.”

Year-to-date data compiled by Prospect News confirmed this observation.

The shortest tenor for S&P 500-linked leveraged capped bullish notes paying 3x up with buffer or barrier protection if the index declines is 18 months, according to the data. The average maturity is 2.13-years and buffers tend to be geared.

Shorter tenors for 3x leveraged notes tied to the S&P can be found, but the downside protection is lacking. The average is 18 months, according to the data.

The most common products in this category are Bank of America’s Accelerated Return Notes on the S&P 500 index providing on a 14-month period 3x upside leveraged exposure with no downside protection. The average maximum return for the 14-month ARNs has been 17% this year, well below the 24.84% top return offered by the bearish note over a nine-month period.

Pure hedge

“Oh wow! Bear notes aren’t usually that big. That’s interesting...and the terms are so different from what we see on the bullish side,” said Tom Balcom, founder of 1650 Wealth Management, referring to the ARNs.

“Typically, it’s a 13- or 14-month maturity so you get the long-term capital gain treatment. With a nine-month term, apparently the client is not focused on taxes. It could be for a retirement account or institutional, either one,” he said.

Investors using the notes would have to be “extremely bearish,” but the main objective of the note is not purely directional, he said.

“You use that as a hedge. You don’t load your portfolio with it because you have to be careful. If the Fed stops raising rates and the market jumps, you could be in trouble. Say the S&P is up 28%, you lose 20% in nine months as the market rallies; that’s a problem.

“So, you have to limit your exposure to this. I would use less than 5% of my portfolio and only as a hedge,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. and UBS Financial Services Inc. are the agents.

The notes settled on Friday.

The Cusip number is 17331D345.

The fee is 0.75%.

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