UBS' absolute return autocallables linked to oil target investors betting on price recovery

By Emma Trincal

New York, June 26 - UBS AG, London Branch's 0% contingent absolute return autocallable optimization securities due July 2, 2013 linked to Brent crude oil are designed for investors who believe that Brent crude oil prices have little room to fail further, sources said.

The notes will be called at par plus an annualized call premium of 11% to 12% if the price of oil closes at or above the initial price on any quarterly observation date. The exact call premium will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called and the final oil price is greater than or equal to the trigger price, 80% of the initial price, the payout at maturity will be par plus the absolute value of the percentage change in the price. Otherwise, investors will be fully exposed to the price decline.

"It has its attractiveness," said Brad Zigler, research analyst at B.L. Zigler & Co., talking about the deal. "If you feel more confident than I that oil prices have seen the worst already, then, yes, it's an interesting volatility play. And you're only talking about one year."

Range bound

Dean Zayed, chief executive officer at Brookstone Capital Management, said that he likes the timing and structure of the product "a lot" because he is relatively bullish on oil.

"It's very attractive because most of the decrease in price has already taken place. I don't see a lot more downside," he said.

If anything, the risk in his view would be to miss some of the upside.

As long as oil prices do not decline by more than 20% at maturity, investors will generate a gain for each point of decline, he noted.

On the upside, investors in the notes will outperform the commodity price if the appreciation remains less than the call premium.

Zayed said that he is bullish and anticipates that prices will trade in that range, which is up but below the 11% or 12% annualized premium.

"If it trades range bound, you're outperforming oil prices either way," he said.

"The risk is to cap your upside if we see a raging bull market. But I don't see that, and if you were that bullish, you would probably not invest in this note.

"There's a high probability that you will be called with a decent premium. In addition to that, you get the liquidity because you're out."

Two risks

For Zigler, two risks are associated with the product.

"You can have oil prices going up and then some extreme volatility kicks in and gives you a loss on the downside," he said.

"Or you could have a strong rise in oil prices, which is not a loss exactly but an opportunity cost because you're not maximizing your upside."

Brent oil futures as traded on the IntercontinentalExchange closed near $93 a barrel on Tuesday.

Since its peak so far this year in mid-March, the price of oil has declined by 27%. It has fallen by more than 14% for the year.

Not everyone believes that the correction is near the end of its term.

"In my view, the downside is where the risk is," Zigler said.

"Getting 11% per year right now would be good because there's a lot going on.

"First, we're in a deflationary environment. The demand is not keeping pace with the supply. That could keep prices down.

"Then we're building some contango, which is the spread between the nearby prices and the deferred prices in the futures curve. That's not good for returns."

While a strong rally is unlikely, a price decline of 20% or more in a one-year timeframe is "entirely possible," he said.

Hedging

Asked whether he is bearish on oil, Zigler said, "My outlook is not very positive, let's put it that way. I see a significant potential for downside if no stimulus is in the offing. The situation is worse in Europe in terms of industrial demand, so I'm not only referring to more Fed stimulus but also to stimulus from European institutions as well, especially since we're talking about Brent crude, the North Atlantic benchmark."

However, for investors who believe that oil prices will be flat or increase slightly over the course of the next 12 months, the notes may have their place in a portfolio so long as the downside risk is understood and possibly hedged, Zigler said.

"For those whose point of view is that oil prices are not going to see a strong rally, which is consistent with recessionary expectations that are weighing on the market, it would work. It would also be a logical play if you don't expect a collapse in oil prices," he said.

"I see a lot of uncertainty on the downside. But there could be a way to hedge this. You could leverage some puts on oil or perhaps use one of those inverse ETNs. ... You'd probably want to use the options as you'd get more leverage rather than having to put down the cash outlay required with the ETNs."

The notes were expected to price Tuesday and will settle Friday.

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

The Cusip number is 90268U523.

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