Citi’s $68 million autocalls on Nasdaq offer double-digit premium but no protection

By Emma Trincal

New York, May 31 – Citigroup Global Markets Holdings Inc.’s $68 million of 0% autocallable securities due May 24, 2027 linked to the Nasdaq-100 index surprised market participants with its big size as well as its terms. The absence of any downside protection was rare for this type of structure, they said.

The securities will be called automatically at par plus 13% if the index closes at or above its initial level on May 20, 2024, according to a 424B2 filing with the Securities and Exchange Commission.

If the index gains, the payout at maturity will be par plus 1.3 times the return. Investors will lose 1% for every 1% that the index declines if it finishes below its barrier.

Timing the correction

“With those structures, you get out with a call premium if the index is up in one year. Otherwise, you can get quite more at maturity with the leverage and unlimited upside,” a market participant said.

“People tend to buy them hoping they won’t get called. This one offers a high enough call premium that makes the call scenario a little bit less disappointing. You can of course underperform if you’re called at 13% and the Nasdaq is up 25%.”

But buyers of the notes are betting on a short-term correction of an index that has performed exceptionally well.

“The rationale is that the Nasdaq will be down a year from now. So, you won’t get called. Then during the remaining three years, chances are that the Nasdaq will rally. The hope is to ride the ensuing bull market.”

“It could be timely. If you can avoid the call, you could capitalize on the recovery,” he said.

High premium, low leverage

Many investors with a bullish outlook buy this kind of structure based on that assumption.

“They see the call premium as a cap, which it is. They don’t want to be called. They want to get the uncapped return at maturity. If you’re bullish, a 1.3x exposure would give you a lot more than the call premium,” he said.

“It’s an autocall, which you hope will become a growth note.”

This note offers some balance, however. Investors get rewarded if their bet turns out to be wrong because the call premium is relatively high, he added.

“It’s a tradeoff,” he said.

Investors are “only” getting 1.3x leverage but the call premium of 13% is relatively high.

Nasdaq vs. S&P

A deal with a four-year tenor priced on the S&P 500 index would typically offer a single-digit call premium of 8% to 9% at the end of the first year, he said. At maturity, investors would generally benefit from 1.8x leverage, no cap and a 75% barrier.

The “big surprise” in the structure was the full downside exposure.

“It’s odd that you don’t have any barrier. The leverage would be even lower if you had one,” he said.

The use of the Nasdaq versus the S&P 500 was the main explanation for the discrepancy between the terms.

“The Nasdaq is more volatile. So, you have more expensive options if you’re not a seller of volatility. That’s one factor.”

The low-dividend paying benchmark is also another reason for the disappointing terms.

“That same deal on the S&P would have shown some downside protection, for sure. The typical S&P four- or five-year note would give you a 75% barrier, 1.6 to 1.8x leverage, no cap and maybe 8% or 9% in call premium.”

Low volatility, dividends

An industry source was also surprised by the terms.

He offered his own explanation.

“Vol. is cheap, so selling the at-the-money put doesn’t net much. You’re not getting much leverage in,” he said.

The sale of an at-the-money put is used to finance the upside. This position is what exposes investors to the full downside risk.

On the other hand, the low volatility made the purchase of the digital call and call options relatively inexpensive, he noted.

While the Nasdaq-100 index is more volatile than the S&P 500, it remains relatively cheap, he added.

Finally, this source agreed that the low dividends limited pricing power.

“Dividends can generate good terms, and the Nasdaq doesn’t pay much in dividends. High-yielding indices like the EAFE almost always offer better terms,” he said.

The dividend yield on the S&P 500 index and on the Nasdaq-100 index is 1.66% and 0.62%, respectively. The MSCI EAFE index has a dividend yield of 2.36%.

Big and expensive

The size of the deal may reflect the appeal of tech stocks as the Nasdaq-100 just hit its highest point since early last year.

“It’s all about momentum-chasing. Last year everybody was buying principal-protection. This year everybody is buying the Nasdaq even if it’s the wrong way to go. Just look at the skyrocketing performance!” he said.

The Nasdaq-100 index has climbed 36.5% from its October low.

But it remains 15% off its November 2021 high.

This industry source offered another explanation for the not so stunning terms, contending that the cost to investors was too high.

“The fee is outrageous at 3.75%. This is very unique. I’ve rarely seen fees that high,” he said.

“They must be working with a large RIA to issue a note of that size. Or possibly, it’s done through a wealth management channel or brokerage house. But that fee is incredible. Rarely do you see notes this expensive.

“If vol. wasn’t so cheap and if this trade wasn’t so pricey, terms would have been a lot better.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes settled on May 24.

The Cusip number is 17331HX43.

The fee is 3.75%.

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