Citi’s $9 million contingent coupon autocalls on three ETFs seen as bet on beaten up sectors

By Emma Trincal

New York, Sept. 16 – Citigroup Global Markets Holdings Inc.’s $9 million of contingent income autocallable securities due Sept. 9, 2022 linked to the least performing of the Financial Select Sector SPDR fund, Energy Select Sector SPDR fund and Utilities Select Sector SPDR fund offer a welcome break to investors trying to move away from the plethora of tech deals supplied by the market in an ever-growing momentum bid.

Less popular, the three sectors put together allowed for the pricing of relatively good terms, a market participant said.

Each quarter, the notes will pay a contingent coupon at the rate of 10% per year if each fund closes at or above its coupon barrier level, 60% of its initial level, on the determination date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par if each fund closes at or above its initial level on any quarterly call determination date.

The payout at maturity will be par unless any fund finishes below its 60% downside threshold, in which case investors will lose 1% for every 1% that the least-performing fund declines from its initial level.

Immediately redeemable

“The 10% coupon is attractive,” the market participant said.

He pointed to the relationship between the coupon level and the absence of any call protection.

“There’s a higher coupon because there’s no ‘no-call,” he said.

“You can be out in three months.

“It used to be you were getting a higher coupon when you were moving the call further out. Now you get a higher coupon by moving the call up.”

One explanation was the shape of the implied volatility curve.

“Normally you expect to be paid more if you can’t get called for a certain period of time because your expected life is at least that great.

“That’s how it used to be.

“Now because of the volatility curve, a shorter call gives you a more attractive coupon. It’s the flip side,” he said.

A good mix

The terms of the product were compelling.

“It’s a big coupon to go along with a deep barrier,” he said.

“These three are the most beaten up sectors, which helps pricing.

“Not only that, financials, energy and utilities are pretty non-correlated.

“The heightened volatility in these sectors on the one hand and the low correlation between them on the other hand, you put that together and you come up with pretty attractive terms.”

Volatility, dividends

The three sectors do not show the same levels of volatility, however.

The financial ETF is the most volatile with an implied volatility of 31.94% followed by the energy ETF, which has a 29.6% implied volatility.

In sharp contrast, the utilities fund showed a 17.34% implied volatility.

“The utilities one has a pretty good yield, so it offsets the lower vol.,” he said.

The utilities ETF yields 3.17% versus 2.43% for the financial fund. The energy ETF has an even higher dividend yield of 5.91%.

“Those high dividend yields help with pricing,” he said.

Some value

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said he liked the valuations of some of the underlying sectors. The financial ETF however appeared to pose the greatest risk.

“If I look at a five-year chart, the Utilities Select is the only one that hasn’t had a big retracement. It doesn’t tend to be that volatile. The energy and the financials are the ones who would have to fall another 40%. That would be a significant move,” he said.

“I like the fact that both energy and utilities are substantially lower today if you go back five years. In fact, we’ve been buying utilities in the last month and a half.

“We do like financials and energy. Both are necessary in any economy.

“However, financials are not as much of a bargain if you go back five years.

“A 40% drop would put them at a level tested in 2016. That doesn’t give you a lot of extra room. There is room but it doesn’t strike me as the safest of the three ETFs.”

To conclude, market risk would have to be analyzed more closely before making any investment decision.

Pool on the other hand said he did not mind the reinvestment risk associated with the probability of an early redemption after three months.

“It’s not a concern. You get called at the end of the first quarter. Fine with me. The client is paid 2.5% for that quarter, which is not bad at all.”

The notes are guaranteed by Citigroup Inc.

The agent is Citigroup Global Markets Inc. with Morgan Stanley & Co. LLC as a dealer.

The notes settled on Sept. 10.

The Cusip number is 17327Y345.

The fee is 2%.

© 2015 Prospect News.
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