Citi’s $3.08 million autocalls on S&P may outperform in different markets, both directions

By Emma Trincal

New York, April 1 – Citigroup Global Markets Holdings Inc.’s $3,079,000 of 0% autocallable dual directional barrier securities due March 25, 2027 linked to the S&P 500 index showed a slightly different “catapult” structure with a 50% participation in the absolute return, which, sources say, may increase the chances of outperforming both sides of the market.

The notes will be automatically called at par plus 10% if the index closes at or above the initial index level on March 31, 2025, according to a 424B2 filing with the Securities and Exchange Commission.

If the final index level is greater than or equal to the initial index level, the payout at maturity will be par plus 126% of the index return. If the index closes below its initial level but at or above the barrier level, 60% of its initial level, the payout will be par plus 50% of the absolute value of the index. Otherwise, investors will be exposed to the decline of the index from its initial level

The note falls into the definition of a “catapult,” a term coined to describe structures combining a one-time autocall paying a premium with uncapped leverage at maturity in the event of no call.

One note, different markets

“This is interesting. You have a typical catapult with this 50% absolute return. It’s different. I like that,” said Ken Nuttall, chief investment officer of BlackDiamond Wealth Management

“The play here is that the market is up in one year and you get your 10%. If not, you still have two years to get your 1.26 times leverage uncapped.”

The two-tier payout was well adapted to current market conditions, he added.

“The argument is that the market is at all-time highs so if you don’t get called and if it’s down at maturity at least you get protected plus you receive half of the absolute return,” he said.

If on the other hand the market is slightly down, it can go back up. The 1.26 times at least takes care of your dividends.”

Different

What was different about the note was the 50% absolute return feature.

For Nuttall, reducing the absolute return participation was a way to improve the terms on the upside.

“I think they did it so they can give you the unlimited upside at a rate of 1.26 times plus some gains on the downside,” he said.

“If it was 100% of the absolute return you would never get 1.26 times on a three-year, especially if there’s no cap.”

For Nuttall, the feature must have been put in place to alleviate some current pricing limitations due to the market.

“Volatility is so low right now you’re just not getting good leverage out there. To be able to deliver the upside leverage, you need to sell some options on this. It would help if options paid more but they don’t.

The VIX index has been trading below 14 for the past two weeks. Currently at 13.65, it is 41% off its one-year high of October.

“Because rates and volatility are so low, you have to be creative on things if you want to increase the upside and offer deeper buffers or barriers. I think that’s what they did here.”

Catapult vs. bullet

He compared the note with a BNP Paribas issue which priced last week. The BNP notes were tied to the worst of the S&P 500 index, the Nasdaq-100 index and the Russell 2000 index. It was a five-year bullet with 1.75 times uncapped leverage at maturity. On the downside investors had 100% of the absolute return at or above the 60% barrier threshold.

“With the five-year you don’t need the autocall to get the leveraged exposure with no cap. The idea here is: in five years, I’ll be up, that’s that kind of logic,” he said.

“The three-year from Citi is more for the undecided investors. There’s an element of risk during shorter periods of time. You’re trying to get a guaranteed return after one year, which is this 10% premium.

“The Citi one is shorter and it’s on a straight S&P, not a worst-of. Both deals show the same barrier. But the Citi gives you only half of the absolute return, not all of it.”

While the three-year structure cuts the absolute return participation in half, it is also more likely to put the benefit of the absolute return to use, he said.

“If you don’t get called on the three-year note, it means you fell down and now, you only have two years to get back. If you can’t, you still get something on the downside. On a five-year you are much less likely to finish negative,” he said.

“I like that Citigroup note. The absolute return, even at 50%, gives you a little bit more to play with.”

Back testing

A financial adviser said he was intrigued both by the catapult structure and by the reduced participation in the absolute return.

He typically evaluates notes based on statistical data on the S&P 500 index for the past 75 years. But his methodology was challenged by the structure type.

“I can only look at a one-year period or a three-year period, which are the two possible types of upside. I don’ t have the statistical tools to extract any kind of probabilities of return point to point for the last three years if the index finishes negative on the first,” he said.

He decided to proceed anyway with the data he had at his disposal.

Call assumption

“I’ll look at the first-year situation first to measure the odds of getting called,” he said.

The chances for the S&P to be positive in a 12-month time are 73.8%, he said.

“Almost three-quarters of the time, you’ll be taken out with a 10% return.

Keeping with this upside bucket, he found a 23.5% chance for the notes to outperform once called, which would happen if the index finished up but below 10%. Inversely note holders would underperform 50.3% of the time with a growth above 10%.

“OK. So, the market is going to do better than you 50% of the time. You’re stuck at 10%. Fine. That’s what you signed for,” he said.

“Would I be okay to take that 10% after one year and walk with it? Yes, I would be,” he said.

A “raging bull” would take no chances, he added.

“But I can make a pretty solid case that getting 10% in one year after the market is coming off a huge run is not unreasonable. We’re up almost 30% over the past year. So, it really depends on how bullish you want to be.”

Overall, the notes were likely to be called at 10% after one year three-quarters of the time.

“Not bad. And if there’s no call, we’re going to get a really fun time,” he said.

Three-year note

This time, this adviser examined the back testing data over three-year rolling periods based on the assumption that investors would hold the security until maturity. This meant the automatic call did not occur, which corresponded to a scenario in which the market began the second year negative.

“First, I will look at the downside, which is what you always need to worry about first,” he said.

“Is 60% big enough on three years?

“I would think so. The chances of being down more than 40% over three years are 0.3%. That gives me a 99.7% chance of not breaching the barrier,” he said.

This adviser admitted that the back testing approach had some limitations due to the catapult structure. While the statistics applying to three-year point-to-point returns were available, they did not track a distribution of return characterized by an index decline at the end of the first year. Therefore, the efficacy of the barrier could not be accurately estimated.

One caveat

The frequency of a barrier breach was only 0.3% out of a 15% probability of a negative return, he noted.

This left a 14.7% chance for the index to finish negative but within the absolute return range.

“Almost 15% of the time, I’m going to outperform on the downside,” he said.

This adviser then looked at the 85% probability bucket for an upside scenario.

“Anytime I’m positive, I’ll outperform because of the leverage and the unlimited return.

“This gives almost a 100% chance of beating the market. Obviously, this can’t be statistically correct. We know that the probabilities are skewed here because the note can only give you a positive return at maturity if you’re negative after the first year. It’s not the same as a straight point-to-point over three years.

“How do we pull that data out without guessing? I’m not sure so I will not guess,” he said.”

Still, this adviser drew some positive conclusions about the double payout offered by the structure.

Pricing

“If I only use the one-year autocall sequence, we’re looking at a 50/50 probability. Most likely, you will get out with 10%. But if it doesn’t happen your odds of doing well are great. Of course it depends on your final performance. If you’re up 2% at maturity, the leverage is not going to add much.

“Despite the limitations of the back testing analysis, it looks like this offering gives you pretty good terms.”

The low fee of 0.1% as disclosed in the prospectus may be one factor, he said.

Another possible cause may be the unusual 50% participation rate in the inverse return.

“I’ve never seen that feature before. I’m sure they did it to increase the size of the barrier. Would I rather have a 60% barrier with 50% of the absolute return or an 80% barrier with the full absolute return? I’m much more comfortable with the 50% absolute return, the way they did it here,” he said.

“I think this note is well priced and can work in different situations. As long as you’re willing to get 10% a year and stick it out for three years, it gives you a fair chance to beat the market.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes settled on Wednesday.

The Cusip number is 17291LUT0.

The fee is 0.1%.

© 2015 Prospect News.
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