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Published on 6/1/2017 in the Prospect News Structured Products Daily.

Citigroup’s enhanced digital plus tied to S&P 500 to offer alpha, buffered protection

By Emma Trincal

New York, June 1 – Citigroup Global Markets Holdings Inc.’s 0% enhanced buffered digital plus securities due June 7, 2022 linked to the S&P 500 index allow investors to get a digital return even in a down market as long as the price drop stays within a range, a sure way to get alpha compared to a long-only position in the market, sources said. Investors also enjoy a buffered protection. In exchange however, investors must contend with a cap further away from the digital threshold and a relatively long duration.

If the index finishes at or above the 85% threshold, the payout at maturity will be par plus the greater of the fixed return of 20% and any gain up to a maximum return of 50%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will be exposed to any losses beyond the 15% buffer.

Step or jump family

“I like this one better than the minimum coupon stuff because at least it has a buffer. With these jump notes or step-ups, you have to have an optimistic forecast because they don’t give you any protection,” said Steve Doucette, financial adviser at Proctor Financial.

He was comparing the Citigroup notes to Bank of America’s market-linked step-up notes as well as similar structures such as Morgan Stanley’s jump securities.

Those two branded products show notable differences with Citi’s buffered digital plus however. Their duration is usually shorter, the upside above the minimum return is not capped and the downside exposure is on a one-to-one basis. Another significant difference is that the payment of the minimum digital payment is triggered at, not below par.

Thin range

Doucette said he would not consider the notes for two reasons.

First, the necessary range to outperform the index was too narrow in his view.

“You’re not getting more than 50% or 10% a year and you’re long the market if the index is above 20%, that’s 4% a year. The only way you’re going to outperform on the upside is if the S&P doesn’t go up more than 4% a year. That gives you a limited probability especially on a five year,” he said.

If the market finishes negative but not down by more than 15%, investors get the best of the notes with a 20% gain.

“If you get that digital return when the market is down, that’s huge,” he said.

But the outperformance potential of the notes requires the index to be contained in a minus 15% to plus 20% range.

“Your prediction is within a very narrow range knowing how volatile the market is. I don’t think I would be comfortable with that,” he said.

Term

Second, the five-year duration was problematic for this adviser.

What made Doucette “uncomfortable” was not so much the downside risk than the risk of missing a rebound following an increasingly predictable bear market. This risk was compounded with the long tenor.

“We know a bear is coming. The hard thing is predicting when,” he said.

“We could go all the way down and then back up at which point you’re capped at 50% and you miss the upswing.”

This “upside” risk depended on how soon a correction would occur. The sooner, the better for the noteholder, he said.

“Bear markets usually don’t last long and then you have the rebound. Look at how quickly the market recovered after the crash in ‘08 and now we’re eight years into a bull market,” he said.

“You have to be pessimistic to buy the notes. You want this buffer and you hope to outperform.

“To me the only uncertainty is time. The five-year duration is a little scary to cap my upside over 50%.”

Fair terms

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he liked the terms of the notes, including the duration, but would have preferred more protection.

“I like the S&P and I’m sure I will like it over the next five years,” he said.

The observation at maturity rather than during the life of the notes was also important to him.

“I do like that it is a minimum payout of 4% so I’m not missing out on my dividend.

“The cap is relatively fair. I would try to look for more but 10% a year is within reason for this index.”

Downside risk

The real drawback was the amount of protection.

“I think going out five years you can get a bigger buffer for that index,” he said.

The current levels of the U.S. equity benchmark warranted to be cautious about a potential market downturn.

“The S&P has been and remains so far the most favorable index but it’s reaching high valuations. So I think having a defensive structure like this one when you want to remain invested in an index that still shows potential, is the right approach. This is why you get into structured notes in general,” he said.

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes are expected to settle on Wednesday.

The Cusip number is 17324CJT4.


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