UBS’ 20.51% trigger yield notes on SPDR Oil & Gas offer high reward for volatile sector bet

By Emma Trincal

New York, May 4 – UBS AG, London Branch in the pricing of $499,884 annualized trigger yield optimization notes due Aug. 5, 2022 linked to the SPDR S&P Oil & Gas Exploration & Production ETF provides a short-term bet on energy paying an eye-catching fixed rate of 20.51%.

The face amount of each note is $132.00, which is equal to the initial share price of the ETF, according to a 424B2 filing with the Securities and Exchange Commission.

Interest is payable monthly.

The payout at maturity will be par unless the final price is less than 80% of the initial share price, in which case investors will receive one ETF share per note.

Volatile underlying

“Obviously, you need to have a huge volatility to be able to get such a coupon and that’s why they picked one of the most volatile ETFs out there. It’s also a fixed rate. It pays more than 5% three months from now. That’s a huge coupon,” a financial adviser said.

“The higher the volatility, the greater the risk and the bigger the coupon.”

The underlying offers an equal-weighted exposure to the share price of oil and gas exploration and production companies. The top three constituents are EQT Corp., Antero Resources Corp. and Southwestern Energy Co.

The implied volatility of the ETF, which trades under the ticker “XOP,” is 49.34%.

Known unknowns

With the high volatility comes the risk of loss at maturity.

The 80% barrier over a three-month period may be “tight,” he said.

“The risk here is a pullback in oil prices. It could happen if we opened up drilling to maximum capacities in order to boost supply. It could also be the case if Russia ceased hostilities in Ukraine. Anytime you increase oil supplies, you run the risk of oil prices falling unless demand is rising just as much. It’s all based on supply and demand.”

Other factors impacting crude oil and making energy stocks more volatile include “economic conditions,” “energy conservation” and “liabilities for environmental damage and general civil liabilities and tax and other governmental regulatory policies,” according to the risk section of the prospectus.

Selling puts

A market participant said the note was a typical reverse convertible but instead of a stock, the issuer used an ETF as underlier.

“It’s a very short-term paper,” he said. Traditional reverse convertible notes, at least a few years back, used to have similar maturities in the three- to six-month range, he added.

Reverse convertible are yield-enhancement notes that utilize high volatility underliers to pay above-average coupons over a short holding period.

“The buyer of the notes is selling a put. Some institutions don’t have the mandate to write options, so they buy notes that do just that.”

“The issuer is selling a knock-in European barrier put with an at-the-money strike,” he added.

The knock-in barrier means that the put option ceases to exist once the price falls below the barrier. At that point, the put will be exercised at the strike price, which is the initial (or at-the-money) level causing the investor to take a loss. The term “European” refers to a barrier that is observed point to point.

“But I think it’s funny that they would pay you a monthly coupon for a three-month note,” he said.

“Why not pay at the end? It seems like a hassle. There’s nothing wrong with it. But it’s weird that you’d get your premium in three monthly coupons instead of a one-time payout.”

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

The notes settled on Wednesday.

The Cusip number is 90303L306.

The fee is 0.7%.

© 2015 Prospect News.
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