Citi’s $11.24 million dual directional notes on Nasdaq designed for moderately bullish bet

By Emma Trincal

New York, Oct. 25 – Citigroup Global Markets Holdings Inc.’s $11.24 million of 0% dual directional trigger PLUS due Jan. 24, 2024 linked to the Nasdaq-100 index provide investors with a chance to outperform the underlying in a range bound market. But they must have limited return expectations in order to tolerate the cap, one adviser said.

If the index return is positive, the payout at maturity will be par plus 200% of the index return subject to a maximum return of par plus 22.8%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive a 1% gain for each 1% loss if the index declines but finishes above the 80% principal barrier and they will lose 1% for every 1% decline if the index ends below its principal barrier.

Cap

Jonathan Tiemann, president of Tiemann Investment Advisors, focused on the cap as it represents the main distinction between a long position and the structure.

“You’re selling the upside for the leverage and the protection. That’s the usual thing,” he said.

“The risk is to breach the 20% barrier in 15 months.”

Assessing such risk without using an options pricing model was “imprecise,” he said.

“The index is down almost 30% for the year. It feels like it’s less likely to go down another 20%, but this type of intuition is not really based on anything rational. Market sentiment and market moves are two different things,” he said.

For Tiemann, investors needed to be compensated not so much for taking the downside risk but for giving up some of the upside.

“If the Nasdaq drops more than 20%, you’re not worse off than if you were long the index. But if the performance exceeds the cap, that’s when you need to be compensated,” he said.

“So, you don’t want the index to go up too much. Above 11.4% there is not additional gain. And 11.5% in 15 months is a good return but not an exceptional return.

“You’re betting on the index trading in mid-range.

“If your return expectations are modest, this would be a note with a sensible shape to it.”

Cost and pricing

Tiemann said he did not have a “good way to estimate” the pricing of the notes.

“But I assume there is a substantial margin for the issuer in the implicit pricing. If you price out the appropriate options at these strike prices, I think you’ll find out that noteholders presumably are overpaying for the options they’re buying and are underpaid for the options they’re selling.

“In other words, you would probably have a higher cap and a lower barrier if you were to replicate this note with options,” he said.

The embedded cost of the structured note was not necessarily unjustified however.

“You’re paying somebody to put this hedge for you. Any adviser would tell you that managing a portfolio of options for a variety of clients is very cumbersome. So, you’re paying for the ease of managing your clients’ assets,” he said.

“Besides I am not pricing the notes so I don’t know to which extent you would be better off doing it yourself. But you certainly would get better terms doing it yourself.”

The notes carry a 2.25% fee, which includes a structuring fee of 0.5%, according to the prospectus.

“It’s expensive for a 15-month term,” he said.

“This fee suggests the deal is designed to be sold rather than to be bought.”

Entry point

Tom Balcom, founder of 1650 Wealth Management, liked the timing of the trade.

“We already had a pullback on the Nasdaq. We are now at a lower entry point,” he said.

The Nasdaq-100 index has declined by 28.5% year to date. It is 30.4% off its peak of November.

“You’d have to be down 50% from the high to breach the barrier. It doesn’t seem very likely to me,” he said.

Absolute return

Balcom examined the downside structure.

“The 20% gives you a nice level of protection given where we are,” he said.

“As long as you don’t breach, the absolute return allows you to make money on the downside too. And since we’re already down quite a lot, you may end up outperforming on the downside. Even getting a 5% positive return if the index is down 5% is nice,” he said.

Balcom said the notes were designed for investors with a sideways view on the market.

“If you’re very bullish, you don’t want the cap. This would not be a trade for you,” he said.

Some investors may prefer a higher cap without the absolute return. This option was not attractive to Balcom.

“I like it the way it is. It’s more balanced that way. You can make money both on the downside and on the upside,” he said.

Balcom was comfortable with the odds of “beating” the benchmark.

“Somewhere between -20% and +22.8%, you’re going to outperform. It’s a pretty wide range for a short-term paper,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes settled on Monday.

The Cusip number is 17330U488.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.