CIBC’s digital notes tied to S&P oil ETF start on time but may end too late, contrarian says

By Emma Trincal

New York, Dec. 7 – Canadian Imperial Bank of Commerce’s 0% digital notes linked to the SPDR S&P Oil & Gas Exploration & Production ETF offer an attractive entry point but may miss the expected rebound of the depressed share price, making the product more adjusted to hedge a portfolio or navigate a choppy market than to take a bullish bet, a contrarian portfolio manager said.

The notes will mature between 18 and 21 months after pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF return is greater than or equal to negative 15%, the payout at maturity will par plus the digital amount expected to be between 17.13% and 20.15%.

If the ETF falls by more than 15%, investors will lose 1.1765% for each 1% decline beyond the 15% buffer.

Shopping spree

“I think it’s great that something is issued at a low point. Issuers should do that more often,” said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

“Oil is down right now, and I’ve been buying some oil-related equity ETFs myself.”

He said he is not buying the underlying ETF, which consists of large-cap, slowly moving stocks with less upside potential. But he recently bought oil services companies through the iShares US Oil Equipment & Services ETF and the VanEck Vectors Oil Services ETF. Both funds are down more than 31% from their last high of early October.

Screening

Still, Kaplan said he liked the underlying of the notes as it fits his contrarian approach at the moment.

First the ETF share price has dropped 29% from the October high of $45 per share. The SPDR S&P Oil & Gas Exploration & Production ETF was trading at $32 a share in the mid-afternoon session on Friday.

Second, Kaplan said he spotted some of his favorite buying triggers: institutions have been buying while the ETF has recorded significant outflows.

“People are panicking. They’re taking their money out. Meanwhile, the smart money has been purchasing record amounts of those oil stock ETFs, even more than at the end of 2008,” he said.

“It hasn’t moved up prices yet because insiders and institutions are outnumbered by the huge crowd of small investors, he said.

“These are all positive things – deeply depressed valuations, insiders buying and people selling. I always look for those conditions.”

Bearish oil trend

Equity oil stocks and ETFs have suffered from the recent drop in oil prices. U.S. West Texas Intermediate crude oil futures contracts went from nearly $77 a barrel in the beginning of October to below $50 at the end of last month.

Part of the drop was due to fears of oversupply and the decline in demand from emerging countries such as China and India, whose stock markets dropped and currencies depreciated, he explained.

“But commodities do fluctuate and it makes a lot of sense to buy at these levels when people are scared. You want to go against the crowd, ignore the emotions,” he said.

Timeframe

The structure of the notes however did not quite match Kaplan’s short-term, bullish outlook.

The short-term tenor, set to be longer than one-and-a-half years but less than two years, was a concern.

“I believe that between now and the early part of 2020... let’s say in the next 14-months, we’ll see some very high points for this ETF,” he said.

“If the fund is up 50% – it’s just an example – you would only get 20%. I would prefer something with no cap especially for such a volatile underlying.”

While it’s impossible to know how much the fund could rise in price, the volatility of the ETF is beyond doubt, he noted.

Today, for instance, the share price is 60% lower than the five-year high recorded in June 2014.

Even on a shorter timeframe, the ETF has lost nearly a third of its value in just a little longer than two months.

“Something that drops so much and so fast is highly volatile. You can expect a strong recovery,” he said.

“Since you’re buying at such low prices, capping yourself is not a good idea if you’re bullish.”

Sell triggers

But the cap was not the only problem. The relatively limited liquidity would add another obstacle if this manager wanted to sell prior to maturity.

“I would use the same methodology to sell only in reverse. If I see huge inflows and a lot of selling on the part of insiders, I would go ahead and sell,” he said.

He expects this to happen within the next eight to 14 months, which unfortunately will precede the maturity date of the notes.

“Once you get into 2020, you run into the risk of a recession,” he said.

“You don’t want to miss the rebound and you don’t want to wait for the next recession.”

Hedging

Kaplan said he understood the notes were not designed for bulls given the cap and the downside threshold.

“It’s more appropriate if you have a range bound view because the -15% trigger allows you to make money on the downside. The 15% buffer is also very good even with the gearing. It’s a good amount of protection from where the price is now.”

Even without a bullish bias, an investor might consider buying the notes as a hedge.

“You could be long the ETF and buy the notes for the downside protection in case you’re wrong.

“You’re willing to give up some of the upside. But you can make up for it a little bit on the downside and treat the notes as a hedge, not a directional bet,” he said.

But for an investor with a short-term bullish outlook like this portfolio manager, the liquidity constraints associated with structured notes in general may be problematic.

“If there was a way to get out sooner, I would perhaps consider it,” he said.

“It’s so rare when you see notes tied to very depressed asset classes. I like this one for this reason.”

CIBC World Markets Corp. is the agent.

The Cusip number is 13605WNK3.

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