Credit Suisse’s knock-out notes linked to SPDR S&P Oil & Gas designed for sideways market

By Emma Trincal

New York, April 24 – Credit Suisse AG, London Branch’s 0% knock-out notes due May 9, 2018 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund are attractive for investors holding a range-bound view about the underlying. But the ETF, which is highly correlated to oil, may have too much volatility for a range-band play, sources said.

The payout at maturity will be par plus 150% of any ETF gain, up to a maximum return of 20.2%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the ETF falls by up to 25% and will be fully exposed to any losses if the ETF finishes below the 75% knock-out level.

Upside target

Matthew Bradbard, director of alternative investments at RCM Alternatives, a managed futures brokerage, said the structure may be profitable in a sideways market.

The commodity trader said his one-year outlook for oil is in a $45-to-$60 range.

Crude oil is currently trading around $50 a barrel.

“If it goes to my upside at $60, it would just be 20%. I don’t see a whole lot of potential upside beyond that, so the cap as far as I’m concerned would not penalize the investor.”

Downside

Bradbard examined the magnitude of the recent bear market in oil. Between a $110-a-barrel high in June 2014 and a $35 low in February 2016, the commodity dropped 68%. During the same time, the ETF price fell 71% from $82 to $24, showing a similar magnitude of decline.

“We’re still close to the lows. ... I don’t see a lot of downside. A 25% drop ... I don’t see that happening. I don’t think you’re going to get anywhere near that.”

For now, Bradbard said that oil is more likely to move in a range.

Equity, natural gas

The notes, which offer leverage to boost moderate returns and an adequate cap, should offer a suitable alternative investment for moderately bullish investors.

But Bradbard said he prefers trading the commodity directly.

“We’re traders. We’d rather buy oil, use leverage and trade both sides,” he said, referring to long and short positions.

Another reason is the asset class.

“This ETF is an equity fund. We trade commodities.”

Finally, the fact that many of the fund’s holdings are natural gas companies is an additional drawback.

“I’m not bullish on natural gas. First, we have this excess supply. If the fund was just tied on oil, it may be OK. But gas prices are much too dependent on currency plays. ... They’re very sensitive to the dollar, to the Fed and also to our own trade policies with countries that buy our energy. Who knows what will happen with this administration?”

The pros

Steven Foldes, vice-chairman at Evensky & Katz/Foldes Financial Wealth Management, said he would not participate in the notes, but he pointed to some beneficial features.

On the positive side, the issuer’s credit is satisfactory.

“Their credit is reasonably strong. We have no big issue with Credit Suisse as it relates to its credit default swaps,” he said.

The first round of the French elections on Sunday, which saw the victory of a moderate along with the far-right candidate, eased the markets, he noted, which was positive for European banks.

“The vote was helpful in terms of calming nerves as it relates to what the European Union will look like without France,” he said.

“European banks, European stocks were the big beneficiaries of this vote.”

Uncertainty weighed on the markets last week ahead of the French election with investors worried about the worst-case scenario: a run off between the far-right and the far-left candidates, as both run anti-European platforms.

A second appealing aspect of the note is its tenor.

“We like short-dated notes. One year is the sweet spot that we like: 12 to 24 months.”

But Foldes had important objections.

Sector

“First, we don’t like to bet on a specific sector.”

Sectors can be rewarding when investors win their bet, but they tend to bring more risk.

No issuer could structure this note on the S&P 500 index, he noted.

The volatility of the underlying is what enabled the issuer to price a product with appealing terms over a short tenor. But Foldes said oil is excessively volatile. The high correlation between oil prices and the underlying ETF make the bet either too risky or not rewarding enough.

Cap

“A 25% barrier you would think is a nice amount of protection. But this is an extremely volatile area. I’d much rather see a buffer because we know how volatile oil is.”

Volatility also means that the share price of the ETF could surge well above the cap level.

“When you invest in a sector, you want to have a big gain. You have to have a high level of conviction.

“But a 20.2% [return] is nothing to write home about when you’re truly bullish.

“If you’re bullish on a sector, you don’t want to be capped at 20%. And if you’re bearish, you don’t want a barrier. You want a buffer.”

Swings versus range

The only reason to buy the notes would be to express a range-bound view, he said.

“But being range bound in such a volatile area ... I’m not sure why anyone would do that given how impactful policies can be on the price of a barrel of oil.”

Foldes pointed to the “huge swings” since 2014.

“From a historical and political perspective, that would not be a view that I would embrace.”

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the agents.

The notes will settle on Wednesday.

The Cusip number is 22548QZZ1.

© 2015 Prospect News.
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