Citi’s $16.09 million buffered autocalls to optimize returns in a sideways market, advisers say

By Emma Trincal

New York, Jan. 24 – Citigroup Global Markets Holdings Inc.’s $16.09 million of buffered autocallable securities due Jan. 21, 2028 linked to the S&P 500 index provide a double-digit call premium triggered below par, which should facilitate the call. But advisers said the notes would only outperform in a sideways market, which they don’t see as the most likely scenario in today’s environment.

If the index closes at or above the call level on any quarterly observation date after one year, the notes will be redeemed at par plus a premium of 11% per year, according to a 424B2 filing with the Securities and Exchange Commission.

The call level will be 90% of the initial level.

If the notes are not called and the index finishes at or above its call level, the payout at maturity will be par plus 55%.

Investors will receive par if the index falls by up to 15% and will lose 1.1765% for each 1% decline beyond the buffer.

Sideways bet

“This is very attractive if you think the market is going to trade in a range between -10% and +10%,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“If you exceed that range, you won’t really benefit from this, and you can easily underperform the index.”

At maturity, investors begin to lose money if the index is down more than 15%. Between minus 15% and minus 10%, they get their principal back. The cumulative premium is earned any time the index finishes above minus 10%.

On the upside, any return in excess of the 11% annualized call premium would represent an opportunity cost for investors, which would underperform the market.

“As long as you expect to be in that -10% to +10% range, it’s a good strategy,” he said.

Downside risk

“The challenge with this range bound view is that it doesn’t take into account the possibility of a big sell-off or recession, which people are talking about.”

Chisholm drew a line between regular and geared buffers.

“As long as the market doesn’t drop more than 15%, you’re fine. But if it does, the buffer is not that attractive because of the gearing. Your losses begin to compound as soon as the index falls below that -15% strike,” he said.

“On the upside you’re stuck with an 11% return if the market takes off.”

Narrow band

The real question for investors was to find out how likely the index may fall within that minus 10% to plus 10% range, he said. To be more precise, the range is between minus 10% and plus 11%, he added.

Since 1928, the S&P 500 index has been closing inside that range only 29.79% of the time, he said.

“In other words, 70% of the time, the market is going against you,” he said.

“You want the market to fall into that range. But historically there is a low probability that it will do that.”

Chisholm said he had no opinion on the future direction of the index.

“I think the market is going to be really hard to predict in the next five years. Chances are it will be all over the place,” he said.

“This note only works for you in a sideways market. If you just look at the probabilities, there is only a small chance this payout will work in your favor.

“I wouldn’t do this.”

Bearish view

For Jonathan Tiemann, president of Tiemann Investment Advisors, the notes were slightly bearish.

“It’s a little odd,” he said.

Investors really profit from this investment when the market is negative but not by more than 10%, he noted.

“You want the market to be down a little and stay that way for a while,” he said.

For this adviser, investors take the risk of not seeing the notes being called throughout the period.

“If the market is really down, you could sit out the whole five years. It’s not very likely but that’s still a risk,” he said.

The call premium is not a good substitute for income, he noted.

“I would not use this as fixed-income replacement. First, because your principal is at risk. But also, you don’t know when you’re going to see some cash,” he said.

Meanwhile most of the “alpha” came from a negative return above the call threshold.

“It’s a bit bearish but it’s not going to protect you against a market crash.

“This is one of those where you’re going to outperform in a narrow range, Tiemann said.

Liquidity risk

One advantage of the notes was to “smooth out” the volatility of the portfolio since a few factors contributed to lower the risk. Those included the buffer at maturity, the lower strike for the call and the quarterly frequency of the observations.

“You’re smoothing out the risk in your portfolio in some sense. But you’re doing that at the risk of getting your money locked in for a while, perhaps longer than you anticipated,” he said.

The benefit of getting cumulative premium, allowing investors to “capture” previously missed returns, did not resolve the liquidity issue, he said.

“If we go through a serious pullback, what you’re giving up, the major sacrifice you’re making here is the liquidity. You don’t know how many years you’ll have to hold the notes for.”

The notes may satisfy some investors with a particular view on the market, he added.

“I’m not too sure what view it is to be honest with you. It’s an odd structure. I don’t really know how I would use it in my portfolio. Five years is a long time. The perspective of being stuck for a long time and not getting out of it while still not earning any income doesn’t really appeal to me.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes settled on Monday.

The Cusip number is 17331CHK6.

The fee is 0%.

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