Citigroup’s dual directional notes tied to Euro Stoxx present challenge of timing bear market

By Emma Trincal

New York, Dec. 10 – Citigroup Inc.’s 0% dual directional barrier securities due June 21, 2017 linked to the Euro Stoxx 50 index offer a chance to significantly outperform the market in a down market, but the chances of profiting from a pullback depend on when and how strong the correction will turn out to be, said a financial adviser.

If the index finishes at or above the barrier level, 80.55% of the initial level, the payout at maturity will be par plus the absolute value of the index return, subject to a maximum return of 19.45%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes below the barrier level, the payout will be par plus the index return, with full exposure to losses.

The final index level will be the average of the closing index levels on the five trading days ending June 16, 2017.

Upside

“At first glance, you have a pretty wide range on the downside. You can be down 20% and get a 20% gain. ... Much better than just getting your principal back. Best-case scenario, you can outperform the index by 40 points. That’s pretty strong,” said Steve Doucette, financial adviser with Proctor Financial.

“On the upside, if you’re bullish, having the cap, which is about 13% a year, is not going to matter much. You might prefer to be long and take away the cap if you’re really bullish, but most people would be happy with the 13% return in this environment.

“If there’s a pullback, a decline by less than 20% after 18 months, your absolute return can accomplish a lot.

“The whole thing is timing.”

Timing

For Doucette, the risk is clearly on the downside.

“You could have a bear market that comes back quickly. You would end in the red without breaching the barrier.

“That’s a good outcome, but how do we know it’s going to be the outcome?

“That’s when you have to go back and do some research on the history of bear markets, looking at how long they last and how much losses they bring.”

The 1973 bear market, he said, lasted almost 21 months. The decline in the S&P 500 index from the peak to the trough amounted to 48%.

The 2000 bear persisted for two and a half years with stocks down 49% of their value, he noted.

The 1987 bear market was brief one – a little bit over three months. The market nevertheless fell by more than a third.

One of the worst bear markets was the one of 2007-2009. While short of 18 months by just one month, it still erased 56.6% of the value of the benchmark.

“Depending on when the bear hits and how long it lasts you could be at the bottom of that bear cycle and just long the index. That would not be good,” he said, alluding to a breached barrier at maturity scenario.

Quick fix

“These notes give you a defined outcome. The only wildcard is timing. And that’s true for all structured notes,” he added.

“I’m not worried about the cap. Nobody is going to complain about making 20% in 18 months,” he said.

“If I had to adjust the structure, I’d want a deeper barrier, probably around 35%. I don’t know if it could be done, but that’s probably what I would be looking at.

“If getting more protection meant a lower cap, I would consider it. Do I really need 13% or 14% a year?

“If it works and I can get more protection on the downside by giving up some of the upside, I would look into it.”

Good for bulls

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he likes the structure as his bullish outlook on the underlying makes him comfortable about the level of protection.

“I like the index. I like the country weightings of the Euro Stoxx 50. There could be as much opportunity in Europe as there is in the U.S.,” he said.

“The dual directional return is appealing, and the fact that it’s point-to-point allows for some positive returns if we’re going to have a short-term correction within that range.

“Over the 18-month period, I’m not concerned with the cap because the 20% level is still attractive for a bull.

“If we see a bear market, and obviously one that doesn’t last the entire 18-month term, the point-to-point is not going to hurt me even if it doesn’t recover to par.”

The risk, however, is a more than 19.45% decline of the index at maturity.

“Sure there’s a risk – without a doubt,” he said.

“But if you look at the [European Central Bank], there is a strong bullish case for European equities because the ECB has shown consistency in the propensity to ease.

“They’re not shy to do it, and they’ll do it if they need to.”

On the upside, the risk of missing out on the return is not a concern to him.

“Getting 13% per year is not an issue, even for a bull. I think the cap they’ve set on this is certainly adequate and fair.”

Citigroup Global Markets Inc. is the underwriter.

The notes will price on Friday and settle Dec. 16.

The Cusip number is 17298C5E4.

© 2015 Prospect News.
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