HSBC’s barrier AMPS linked to Energy Select Sector SPDR fit renewed bullish interest in oil

By Emma Trincal

New York, April 21 – HSBC USA Inc.’s 0% barrier Accelerated Market Participation Securities due October 2018 linked to the Energy Select Sector SPDR fund may appeal to investors encouraged by the recent oil rally in a deeply uncertain geopolitical environment, a portfolio manager said.

The payout at maturity will be par plus 1.5 times any gain in the fund, up to a maximum return that is expected to be at least 50% and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 25% and will be fully exposed to any losses if the fund finishes below the 75% barrier.

“Given the uncertainty of oil prices, the difficulty of making any predictions at this point in this rapidly changing geopolitical environment, the structured note is a reasonable way of playing a sideways market,” said Elliot Noma, founder of Garrett Asset Management, LLC.

“For someone who is bullish long term but expects the market to continue to be choppy short term, it makes sense.”

The underlying fund, which does not track the price of oil but rather the stock prices of oil and gas companies, is fairly correlated with the price of the commodity, sources said.

Bullish positions on West Texas Intermediate crude oil futures contracts have reached their highest levels since August, according to the Commodity Futures Trading Commission.

WTI is one of the two major benchmarks for oil prices.

After a peak above $100 a barrel, WTI futures contracts fell to $43 in mid-March and closed above $55 on Tuesday.

Geopolitics

Geopolitical risks in the Middle East have helped to reverse the bearish trend seen since last summer, said Noma.

“The news at the end of last year was that the Saudis were not going to cut production, the U.S. was going to continue to pump oil at very high levels and production was going to go up. As a result, crude oil prices tumbled,” he said.

“We knew that at some point we would hit a floor. Production in the U.S. continued to go up, but oil companies stopped drilling.

“Prices started to stabilize around mid-January to early February.”

Prices are rising again (up 28% in a month), and the market is still unpredictable as no one has really called a floor yet, he noted.

“The next issue to think of is politics, specifically with the situation in Yemen and Libya, which continues to deteriorate. Yemen has pushed up the price of oil. Meanwhile, the uncertainty around the signature of a treaty with Iran has made the market very choppy,” he said.

“The long-term impact of the rivalry between Iran and Saudi Arabia would likely be disruptive.”

Noma said several geopolitical factors are bullish for oil right now.

“There’s a bullish case to be made if you believe that the conflict between Saudi Arabia and Iran for supremacy will get a lot worse. Any attacks in the Strait of Hormuz, which is a crucial transit spot for global oil shipping, would be a severe disruption, inflating prices immediately.”

Sideways bet

But other factors could also indicate that the oil rally may be short-lived.

“There’s still concern around China. Their growth and demand for oil are clearly slowing,” he said.

“We also don’t know what the breakeven point is in the U.S. for fracking. At what price should you give up drilling? Obviously it’s at less than $100. Production exploded at $100. It’s also more than $20 or $30. But no one really knows the exact point.

“There are a bunch of trends going on. Everybody has their own view. But there is no consensus.

“This note is designed for this type of market. It’s for an investor who is bullish on oil but lacks a strong conviction.

“If you think oil will trade sideways, it makes sense to lever up your position and it seems reasonable to give away some of the upside.

“The 25% downside protection is part of the same idea. It’s a three-and-a- half-year note, and there’s plenty of lead time. It’s probably worth buying some insurance.”

Low cap

Steven Foldes, vice chairman of Evensky & Katz / Foldes Financial Wealth Management, said the upside is not sufficient given how low oil prices are at the present.

“This note is a little bit on the long side for us,” he said.

“The leverage is nice. The 25% barrier, that’s not bad.

“But besides the length, our main objection is the cap.

“For an energy investment on a three-and-a-half-year term, 50% is unreasonably low, especially because of where prices are at today.”

The 50% cap represents a 12.3% annualized return on a compounded basis. It takes an 8.6% annual growth in the underlying fund to reach the cap.

“If we have an uptick of oil, you’re going to be capped out,” he said.

“Investing in oil has to be opportunistic. Given the precipitous decline of oil since its peak last summer, why would you want to limit your gains?

“While it’s nice to have some leverage and downside protection, the 50% cap is so low ... for us it’s a non-starter.

“Oil may or may not increase. It depends on your view. But if it does increase, I want to participate. I will invest in a vehicle that will allow me to get the full benefit of the upside.”

HSBC Securities (USA) Inc. is the agent.

The notes will price and settle in April.

The Cusip number is 40433BU48.

© 2015 Prospect News.
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