Citi’s autocall contingent coupon notes on Dow, gold miners show buffer, low-correlated assets

By Emma Trincal

New York, April 17 – Citigroup Global Markets Holdings Inc.’s autocallable contingent coupon equity-linked securities due May 4, 2023 linked to the least performing of the Dow Jones industrial average and the VanEck Vectors Gold Miners exchange-traded fund offer a rare example of a so-called Phoenix autocallable product with a buffer in place of a barrier, said Tim Mortimer, managing director at Future Value Consultants.

Phoenix autocallable notes offer the option to pay a coupon under conditions that are different and typically easier to meet than those needed to exercise the call. To put it simply, the coupon barrier is lower than the call trigger.

Each month, the notes pay a contingent coupon at the rate of 11% to 13% per year if the least-performing underlier closes at or above its coupon barrier value, 75% of its initial share price, on the valuation date for that period.

The notes will be automatically called at par plus the coupon if the least-performing underlier closes at or above its initial level on any quarterly call observation date after six months.

Investors will receive par if either underlying falls by 25% or less and will lose 1% for every 1% that the lesser-performing underlying declines beyond 25%.

Hard protection

“The use of a buffer in a Phoenix is not common. You usually get a barrier, which is cheaper,” said Mortimer.

“A buffer reduces your losses. You always have it while a barrier can make the protection disappear if it is knocked out.”

The 12% contingent coupon was also competitive.

“It’s quite a high level of income.”

Correlation

This was made possible by the contingency of the coupon, the autocallable feature, the worst-of payout as it is the case with similar products. But in the case of this note, the choice of the two underlying helped provide both the above-average return and the hard buffer.

“The correlation between the gold miners and the Dow is quite low. It’s only 70%,” he said.

A perfect correlation between two assets would be 100%. The S&P 500 index and the Dow for instance display correlation levels north of 98%.

Volatilities

Also, the ETF is much more volatile than the equity benchmark with implied volatility levels of 53% and 24%, respectively, he noted.

“Even the Dow is more volatile than usual due to the current uncertainty in the market,” he said.

This combination of low correlation and high volatility helped the pricing of compelling terms, he added.

“It gives quite a bit of value in the option.”

The net spread between buying the options and selling them provides enough “net credit” to enhance the terms both on the upside and on the downside.

No memory, but monthly

Less significant but still helpful: the coupons do not offer a “memory” feature, which means that any missed coupon at previous observation dates is not going to be paid back, according to a 424B2 filing with the Securities and Exchange Commission.

Stress-testing

Next, Mortimer analyzed the report he generated on the notes.

Future Value Consultants offers structured products stress-testing reports.

Each report contains 29 tests or tables. The Monte Carlo simulation is based on hypothetical growth rates and volatility levels applying to the underlying. The firm runs first a neutral scenario, the basis of the simulation in all reports. It reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying.

First call

One of the most used tables is the scorecard. It provides probabilities of occurrence for all possible outcomes of product performance.

This table shows a 36.16% probability of an automatic call on the first observation date, six months from the trade date.

“For autocalls on a single asset, this probability is usually 50%. It’s lower here because you need both underlying to be up. The low correlation makes this condition even more difficult to meet,” he said.

Losses

There is a 31.8% chance of losing money even after coupon payments. The average loss in this case is 39.8%.

While the buffer should reduce the losses compared to a barrier, other factors counterbalance this factor and contribute to adding risk, which explain how the high coupon was made possible, he said.

With the two-underlying showing a relatively low correlation, the odds of one performing poorly are greater.

The highly volatile gold fund exacerbates the dispersion risk.

“Anyone investing in that note can have a neutral or even slightly bearish view on the assets as long as they don’t anticipate a price drop below 25%,” he said.

“The buffer makes the product a little bit more appealing to cautious investors.

“But the chances of losing money can’t be ignored.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will price on April 30.

The Cusip number is 17328VN63.

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