UBS’s trigger phoenix autocalls on Energy ETF offer likely gain, portfolio manager says

By Emma Trincal

New York, April 24 – UBS AG, London Branch’s $100,000 of trigger phoenix autocallable optimization securities due April 26, 2021 linked to the common stock of Energy Select Sector SPDR Fund maximize investors’ chances to generate a positive return, even short-term, given how hard hit oil stocks have been, said a contrarian investor who is bullish on the unloved sector.

If the Energy stock closes at or above the trigger price – 65% of the initial share price – on a quarterly observation date, the issuer will pay a contingent coupon for that quarter at the rate of 22.51%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, no coupon will be paid that quarter.

If the shares close at or above the initial price on a quarterly observation date, the notes will be called at par plus the contingent coupon.

If the notes are not called and the Energy shares finish at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

High chances to win

“I think it’s a good deal,” said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments LLC.

“Of course, you could get more than 22% owning the shares directly. But there’s a tradeoff with the 35% protection.”

The automatic call after three months increased the odds of not getting the full 22.51% coupon.

“But the chances of getting called are pretty high. You’re buying something that gives you a high probability of making a profit, and I think that’s the main benefit.”

Kaplan said he would not personally invest in the notes because his outlook on energy stocks is too bullish to allow him to tolerate a cap.

“But it would definitely be something to consider as part of a balanced portfolio. The barrier lowers the volatility of your exposure to the sector. It’s always a good thing to mitigate your risk.”

Overdone sell-off

To be sure volatility in oil stocks has been rampant.

“Obviously, this is one of the asset classes that has been very depressed,” he said.

“This ETF has been extremely oversold since March 2018. The price is right now at record lows not seen in the past 30 to 40 years. In March prices were lower than in 2009, lower than in 2002, lower than in the early 80’s.”

For this portfolio manager, the sector is excessively oversold.

“Prices are at irrationally low levels,” he said.

One of the most obvious explanations for the low prices are the global policy responses against the coronavirus pandemic. With most countries in lockdown, demand for oil has collapsed. But Kaplan sees the trend as temporary.

“It’s driven by the current decrease in demand for oil. But people will always have to heat their houses, cook, drive their cars and at some point, travel,” he said.

Negative prices

Several events in the past few weeks has turned sentiment excessively bearish.

Kaplan often criticizes media coverage for “hyping” facts. But he also uses headlines as a contrarian indicator betting against commonly accepted views.

On April 20, the West Texas Intermediate crude oil futures for May fell into negative territory. It was the first time in history.

“People got fixated with what happened in the futures market on Monday,” he said.

“The main reason for the price collapse is that holders of the expiring May futures contracts were desperate to roll over into futures months.

“Those who own the farther months contracts know that traders holding expiring futures will be desperate to sell at any price in order to buy a future month. Even when there isn't a price collapse this leads to a huge contango as expiration is approaching.”

Contango is a term that designates the positive slope of futures contract forward curve.

Futures investors do not take physical delivery of the commodity. Instead, they roll the contracts.

If contracts maturing further into the future are priced higher than shorter-term ones, investors incur a cost as they have to sell the expiring contracts at a lower price than the price at which the distant delivery month must be bought.

Kaplan explained that the spike in the price of storage was the real culprit for the negative price anomaly seen last week.

“Futures traders could not find enough physical traders to take delivery on the expiring positions. The price of storage surged.

“Prices for May contracts have plummeted as a result. But it was not the same for June, which shows that the problem was essentially about physical delivery and soaring storage costs,” he said.

Russians and Saudis

Other sensational headlines came out earlier last month when the price of oil dropped 25% in one day.

One more time, the media failed to provide the correct explanation, he said.

“They attributed the price drop to Russia and Saudi Arabia unable to agree to cut production.

“All of that was just talk.

“If you look at the OPEC reports, you’ll see that supply has actually contracted.

“Think about it: oil is cheap because demand is weak due to lockdown measures everywhere. These countries have a real incentive to reduce their output. Why would you want to maintain or increase your output when there is no demand?”

In addition, Russia and Saudi Arabia do not produce data as reliable as the numbers generated in the United States, he noted.

“It’s hard to know what those two countries are doing. They’re probably playing some game.”

Meanwhile, in the United States, which is the top oil producer in the world, the trend has been to cut production.

“The U.S. oil rig count is way down,” he said.

A report by Baker Hughes released on Friday showed a drop of the rig count of 53% from a year ago to 465 and a 12% decline from 529 last week.

“The mechanics of supply and demand in the oil market are very subtle. Prices are down and the media conclude there is excess supply. But it doesn’t work that way. Supply and demand have to adjust and there’s a delay in adjusting. It’s a much more complicated process than what the headlines are telling,” he said.

Not purely correlated

Kaplan stressed that investing in the equity ETF is not the same as betting on oil prices.

The commodity and the stocks of oil companies while correlated do not move in perfect synchronicity.

“Oil has been down since the beginning of the year and continues to go down. But since March 18, the share price of the ETF has been making higher highs.”

Since that date indeed the ETF has jumped by 45%. Meanwhile front-month WTI oil contracts have declined by 26%.

Market moods

Kaplan said he is bullish on the ETF because he sees a buying opportunity amid excessive fears among market participants.

“The market always reacts and very often, overreacts,” he said.

“Matador collapsed over 90% and has since quadrupled. The market always over anticipates the future and then has to correct that over anticipation,” he said.

Matador Resources Co. is an independent oil producer.

“You get a real opportunity to make money when you see that type of disconnect,” he said.

Solvency

Oil bears are concerned about bankruptcies in the oil sector. After all many U.S. oil companies have invested billions of dollars based on oil prices above $50 a barrel. Here again, Kaplan put such view in perspective.

His main point was the solidity of the constituents of the Energy Select Sector SPDR Fund.

“These are very well-established and among the largest capitalized companies,” he said.

The two top holdings for instance – Chevron Corp. and Exxon Mobil Corp. – have a 45% combined weighting.

“Will there be solvency issues in the sector due to the cheap price of oil? Possibly. But the companies in this ETF are very conservatively run. This ETF is one of the least volatile energy funds there is,” he said.

“Besides the government would never allow those big oil companies to fail.”

If some bankruptcies may arise, consolidations will likely be the natural answer.

“You could see buyouts and I think that’s coming. But the sector overall will rebound,” he said.

Insiders

If the bears have a case right now, they may not be right for too long, he noted, adding that bearish cycles in oil are usually short-lived.

He gave an example of a downtrend: from July to December 2008, oil prices went from a record high to their lowest.

Inversely oil jumped by 60% in 2016 between February and June.

When a sector like oil stocks is especially hard hit, it is worth checking insiders’ recent activity, Kaplan said.

“Insiders are not paying attention to media coverage. They are heavy buyers of oil stocks now.

“If an executive or someone who spent his whole life in the industry is buying shares of his own company, you definitely want to pay attention. It’s a bullish signal and that’s much more relevant than any media story.”

In conclusion, Kaplan said he liked the notes for their low entry price, high margin of safety and for the high likelihood to generate a short-term profit. Any more bullish view though should be played being long the shares.

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes (Cusip: 90289G578) priced on April 21.

The fee is 1.5%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.