BMO’s $1.65 million autocalls on gold ETFs offer timely volatility play, less dispersion risk

By Emma Trincal

New York, Feb. 5 – Bank of Montreal’s $1.65 million of autocallable barrier notes with a contingent coupon due April 30, 2021 linked to the VanEck Vectors Gold Miners ETF and the VanEck Vectors Junior Gold Miners ETF come at a time of increased volatility for gold, which enabled the issuer to offer a generous double-digit coupon, sources said. The correlation between the two underlying funds make the worst-of structure a safer play, they added.

Every month, the notes will pay a coupon equal to 11% per year if each fund’s share price is at least 65% of the initial share price on the observation date for that month, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically redeemed at par plus the contingent coupon if each ETF’s shares close above its initial share price on any observation date beginning in July.

If the notes are not called, the payout at maturity will be par unless the final share price of either fund is less than the initial price and either fund has closed below 65% of the initial share price during the life of the notes, in which case investors will lose 1% for each 1% decline from the initial share price of the least performing fund.

Rich levels

Investing in autocallable notes makes sense when investors’ outlook is not widely bullish, a derivatives analyst said.

“Gold is pretty toppish right now. This is for someone who doesn’t want to own gold or the gold miners because a long position would be too expensive,” he said.

“You’re getting paid from the volatility premium. You’re selling volatility to get the coupon.”

VanEck Vectors Gold Miners ETF tracks the performance of large-cap gold mining stocks. It trades on the NYSE Arca under the ticker “GDX.”

Its sister fund, the “junior gold miners” ETF with a symbol of “GDXJ,” tracks the performance of gold mining companies in earlier development stages with small market-capitalization.

Correlations

Both funds, as they track the same types of companies, are highly correlated. Both also display – although to a lower extent – a positive correlation with the precious metal.

Gold for instance is up 2.6% for the year while the VanEck Vectors Gold Miners and the “Junior” Vector fund have lost 4.2% and 4.4%, respectively.

However, the price of gold has gone through a bullish phase since October 2018, which picked up in momentum in May of last year. The price of gold has increased by 21.5% since May.

Recent price moves

“The two ETFs have dropped in price this year and volatility has picked up a bit,” said the analyst.

“The implied volatility on GDX was 21% around mid-December. On Thursday, it was at 24.5%.”

The notes priced last week on Thursday.

“The implied vol. has been up since the beginning of the year, hovering around 25%.

“It’s not a bad time to get some premium. It would be the equivalent of selling puts although you don’t have a hard protection,” the analyst said.

In comparison, the volatility of S&P 500 index options, as measured by the CBOE Volatility index, was at 15.5% on the pricing day.

Chinese jewels

Higher volatility and toppish values make for good coupons, but the downside risk increases as well.

“There is still a bullish case for gold because rates are so low and uncertainty is rising globally,” he said.

“There’s been a significant inflow in those ETFs in the past couple of years.

“Now there are increasing fears around the coronavirus, which is hitting China. The fear is that long-term, any slowdown in China could negatively impact gold. China is a very large component of global jewelry demand.”

The notes may provide an attractive way to mitigate some of that risk.

“A 35% move on the downside would be substantial. They’re giving you a pretty good cushion.

“It seems like a good play if you’re moderately bullish.”

Neutral bet

A financial adviser agreed. The notes were not geared to bulls but could accommodate a range bound outlook.

“If you’re bullish, you can always own the shares of GDX and GDXJ. You can even own the funds along with the note to hedge some of the risk,” he said.

“The good thing is that the share prices don’t have to go up. Prices can even drop. As long as it’s not down more than 35%, you will get paid.

“It does seem like a good deal.”

The timing of the deal may also be favorable.

“Gold has started to flatten a little bit for the past few weeks. It could start moving higher especially if tech doesn’t do as well, which would incite investors to look at alternatives,” he said.

Another good feature was the correlation between the two underliers. Their coefficient of correlation is 0.97.

“They’re extremely correlated. Even though one is large-cap, the other, small-cap, they’re not that different,” he said.

“Since you’re dealing with a worst-of, the risk of discrepancy between the two is strongly reduced.”

BMO Capital Markets Corp. is the agent.

The notes (Cusip: 06367WUD3) settled on Tuesday.

The fee is 0.75%.

© 2015 Prospect News.
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