Citigroup’s contingent coupon autocallables boost yield with two stocks, worst of feature

By Emma Trincal

New York, June 23 – Citigroup Global Markets Holdings Inc.’s autocallable contingent coupon equity-linked securities due July 2, 2019 linked to the worse performing of the common stocks of JPMorgan Chase & Co. and American Express Co. combine the use of single stocks and a worst of payout to generate a higher premium, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes will pay a contingent semiannual coupon at an annualized rate of 8% to 9% if each stock closes at or above its 80% coupon barrier on the valuation date for that period, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each stock closes at or above its initial share price on any quarterly valuation date from December 2017 through December 2018.

The payout at maturity will be par plus the contingent coupon unless either stock finishes below the 80% barrier level, in which case investors will receive a number of shares of the worse performing stock equal to $1,000 divided by the initial share price.

Volatility

The underlying stocks have implied volatilities of 20.6% for American Express Co. and 21.07% for JPMorgan. In comparison, the S&P 500 index has an implied volatility of 15.70%.

“Those stocks are more volatile than the S&P, of course, but as individual stocks they’re not particularly volatile,” Hampson said.

“The issuer chose single stocks to get a little bit more premium,” she added.

Future Value Consultants provides stress test reports on structured products.

To run the model, Hampson used a hypothetical contingent coupon of 8.5%.

The worst of option, which via correlation introduces another type of risk, was also used in the notes as a way to enhance the yield.

“While the two stocks are somewhat correlated given that they’re both financial companies, the worst of is still going to help. If you pick stocks and then add the worst of it gives you a different type of outcome,” she said.

Time without a call

Investors may be called every six months. They may also receive their coupon payment without the early redemption as long as the worst-performing stock closes above the 80% coupon barrier but below its initial price, she said.

“Naturally, as time goes on, it becomes less likely for you to collect the coupon and continue to hold the note,” she said.

This reflects the two opposite effects of each autocall, she explained.

“It’s a good outcome to be called because you’re no longer at risk. But if you’re in the note to get some income as long as possible, then it’s not the best outcome.”

She illustrated that point using one of the 29 tables offered by Future Value Consultants.

Product specific tests

One table called “product specific tests” displays probabilities of different outcomes. For this particular note, the main outcomes are the breach of the barrier, the call at various dates and the number of times the payment occurs.

The table displays the result under the neutral scenario, which is the baseline growth assumption for the underlying stocks. As it does in all of its reports, the research firm adds four other market scenarios, which are bullish, bearish, less volatile and more volatile. Those scenarios are based on relatively conservative underlying asset growth assumptions.

Not surprisingly, the table shows that the best market condition to reduce the risk of a barrier breach is bullish. Probabilities attached to this outcome are 19.04% in the bull scenario versus 42.10% in the bear market and 27.44% in the neutral market.

Bulls leave early

The table displays probabilities for a call at point one, point two, point three and point four, which represents the four semi-annual observation dates. As with all autocallables, the probability of a call is the highest on the first call point.

“What’s interesting here is to compare the results based on the market. The bull scenario is going to give you the highest probability of a call on the first date,” she said.

There is a 46.80% chance of a call at point one in the bull market. This probability decreases to 37.97% in the neutral scenario. The less volatile scenario, the second most likely, displays a probability of 38.55%.

The bull market also provides the greatest chances of a call at point two and three as well.

The early redemption outcome may be best for investors seeking short-term bets, doing the equivalent of a trader closing his position to lock in the gain before rolling into a new trade, she said.

“It limits your risk. But you haven’t got the maximum return,” she said.

Staying in

At the other end of the spectrum are the chances of being paid a coupon for the longest possible time.

The table shows probabilities for one, two, three and four coupons paid in four distinct rows.

In this case, the bullish environment is the worst for investors seeking to maximize their income, the table shows.

Investors in the bull market have the lowest chance of earning the four payments. This outcome has a probability of only 5.32%, according to the table. On the other hand, the less volatile market environment offers the best opportunity with a 13.45% probability.

“This is pretty self-explanatory,” Hampson said.

“Because the bull assumption is where you’re the most likely to be called especially earlier, the chances of getting to call point three or four are going to decrease. You need the product not to be called for the coupon to be paid until the end,” she said.

Call and consequences

Investors who buy autocallable contingent coupon notes, whether it be linked to a worst of or a single underlier, need to understand the implications of the call, especially if their main objective is to receive income, she said.

Compared to an autocall when investors only get paid upon the call, these contingent coupon notes, sometimes called “phoenix” are “a little bit more complicated,” she said.

“You want the autocall because it protects your capital. At the same time you want to receive your coupon.

“There is a kind of contradiction.

“What the test is showing is that the bull and the less volatile scenario are the best market environments.

“Whether you’re better off in the bull or less volatile scenario really depends on how much you need the income stream.”

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will price on Tuesday.

The Cusip number is 17324XCG3.

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