CIBC’s $126.84 million digital notes on S&P 500 raise the odds of gains, adviser says

By Emma Trincal

New York, Nov. 7 – Canadian Imperial Bank of Commerce’s $126.84 million of 0% digital index-linked notes due Nov. 5, 2024 linked to the S&P 500 index give investors a fair chance to score a positive return due to the combination of a buffered protection on the downside, an “in-the-money” digital option and a competitive fixed payout, advisers said.

If the index finishes at or above its 80% buffer level, the payout at maturity will be par plus 19.75%, according to a 424B2 filing with the Securities and Exchange Commission.

The digital option is “in-the-money” since the initial price of 100% is above the 80% option strike.

Otherwise, investors will lose 1.25% for every 1% that the index declines beyond 20%.

“The terms are good,” a financial adviser said.

“It’s a short-dated note. In current circumstances, I know a lot of people who would be willing to give up some upside for the downside protection and a chance to outperform big time. A year ago, no one would have bought that kind of note. But now with the uncertainty that we have in this market, I can see why they had such a big size offering.”

Rounding up the 19.75% digital return to 20%, this adviser observed that investors will outperform the index within a wide band comprised between -20% and +20%.

“That’s the sweet spot,” he said.

“If you’re down 20% you’ll outperform by 40%. That’s pretty exciting.”

This adviser explored the risk associated with negative index returns at maturity. Overall, the downside protection combined with a quick back-testing analysis of the S&P 500 index data made him “feel comfortable” about the downside risk.

Downside protection

“You’re only going to lose money if the S&P is down more than 20% in two years. The chances for this to happen over a two-year period are only 5.5% based on historical data for the past 70 years,” he said.

“So yes, there’s some risk. For a conservative investor it’s not insignificant, in other words, it’s not like buying a CD. But it’s not a high level of risk either.”

Some of that risk was mitigated by the fact that the S&P 500 index has already dropped 20% since the start of the year, he noted.

“Another 20% drop from where we are right now seems unlikely. However, I don’t have data for that. I wouldn’t know how to quantify the probabilities based on that. My guess is that you obviously have a less than 5% chance to finish below the buffer.”

Since the downside is protected by a buffer and not a barrier, investors will still outperform the index on the downside.

“The index is down 50%, you lose 37.5%. You’re still going to do much better on the downside,” he said.

The frequency at which the S&P 500 index dropped more than 30% or 40% is very limited, he said, based on his 70-year data on the index performance.

“Over two-year rolling periods, a decline of 40% happened only 1% of the time. It’s always possible, but highly unlikely,” he said.

Tax advantage

Some investors are averse to geared buffers because in theory they may lose their entire investment. That possibility, even if infinitely small, has the advantage of giving the notes an enhanced tax treatment.

“It’s my understanding that anytime your principal is 100% at risk, you get the capital gains tax treatment,” he said.

“That’s a great advantage for clients in taxable accounts.”

The prospectus stated that investors should be able to recognize capital gain or loss because the notes are treated as prepaid cash-settled derivative contracts.

Overall, this adviser said he was satisfied with the downside payout.

“I wouldn’t want an 80% barrier. But with this buffer, even with the gearing, I feel pretty good about the downside protection,” he said.

Risk-adjusted return

The notes are attractive for investors who are relatively bearish or unwilling to take on too much equity risk, he said.

For the more bullish investors, the digital, which caps the upside at 19.75%, could be an issue.

“You won’t make more than 20% in two-years. You’re obviously taking the risk of leaving some gains on the table,” he said.

Statistically, the index has gained more than 20% over a two-year timeframe 45% of the time.

“So, you have a good chance, almost 50% chance of being capped out.”

Bullish investors would probably not buy the notes, he said.

“For the optimistic investor who is convinced that the market will come roaring back, it’s a deal-breaker. If you tell them that they have a 45% chance of underperforming the market, they will say: why would I do that?” he said.

But for many of this adviser’s clients, the notes offered a satisfying risk-adjusted reward.

“If you take more risk, you can make more money. But in this type of market environment, a lot of people would be more than happy to get almost 10% a year for a limited amount of risk,” he said.

“I like this note for the downside protection and the 20% boost, which you get up to a 20% decline. There’s a high likelihood that you will receive that 20% payout. You may be leaving some money on the table. Maybe the S&P will be up 50% in two years. But you’re still getting an equity-type of return for the equity risk you’re taking.”

Timing

Andrew Valentine Pool, main trader at Regatta Research & Money Management, also found the notes attractive based on his market outlook.

“I kind of like it. We’re down 20% so far. If we breach, I don’t have a problem with that since it’s a buffer. We could see more downside but at the end of the two years, the S&P should finish above that buffer level,” he said.

“It’s likely that inflation will lessen quite a bit soon, so I think the Fed is going to pivot within the next 12 months. It will allow for some gains, at least more gains versus losses. I can see the Fed slowing the pace of tightening in the next 12 months and that will change the outlook for the S&P.”

Pool had a range bound view on the market for the period.

“I can see the S&P being flat after two years. While we may have a recovery, I don’t see the rally being that strong,” he said.

“We’ve had a lot of liquidity in the system, and it contributed to inflate asset prices for a long time. We won’t have that looking forward. So, the digital return of 19.75% should really help. Timewise I like this deal.

“If it was a one-year, I wouldn’t like it as much.

“But 24-month ... that’s enough time for the world economy to slow down and for the government’s monetary policy to be a little bit loose again.”

CIBC World Markets Corp. is the agent.

The notes will settle on Tuesday.

The Cusip number is 13607XCN5.

The fee is 1.47%.

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