Deep barrier is key with UBS’ $15.41 million trigger in-digital notes on ICE Brent futures

By Emma Trincal

New York, May 23 – UBS AG, London Branch’s $15.41 million of 0% trigger in-digital securities due June 24, 2024 linked to the ICE Brent Crude futures contract allow investors to outperform the underlying commodity even if oil prices decline significantly. Given the volatility of the asset class, the main question for investors is whether the issuer offered sufficient downside protection via the barrier.

If the final level of the commodity is greater than or equal to its digital barrier, 60% of its initial level, the payout at maturity will be par of $10 plus 11.63%, according to a 424B2 filing with the Securities and Exchange Commission.

If the final level of the commodity is less than its digital barrier, investors will lose 1% for every 1% that the commodity declines from its initial level.

Declining prices

The oil market is trading at lows not seen since the end of 2021. Brent crude oil prices, since peaking in March 2022 following Russia’s invasion of Ukraine, are now down nearly 40% as investors worry about an upcoming recession.

The initial level of the underlying on the trade date was $76.96, setting the barrier level at $46.18, according to the prospectus.

“A 40% drop. That would take you to a very low price,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“It would bring us back to the end of 2020. We shouldn’t be hitting that number. It’s always possible of course but it’s unlikely even under a recession scenario. You would have to be in a really bad recession,” he said.

Complex market

A more likely price move, according to this adviser, would be upward.

“If anything, I can see oil prices rising rather than falling. As long as we’re underinvesting in the oil sector, as long as inventories continue to dry out, we’ll see the market leaning toward higher prices,” he said.

For Chisholm, the current depression in prices is not a long-standing trend.

“The lack of supply is a major macro trend. It will continue,” he said.

“That said, predicting oil prices is notoriously difficult.”

Many factors can impact the commodity prices including rising global demand, inventory levels, storage capacities, sentiment and other fundamentals.

“It’s always a combination of supply and demand and more. Oil is a complex market to assess,” he said.

“In my view, oil is likely to trade sideways for a long period of time.”

Even though Chisholm is slightly more bullish than bearish, having a margin of safety is always helpful, he added.

“There is an asymmetry between the -40% on the downside and the 11.63% on the upside. Some people may want to raise the cap and reduce the protection size. I wouldn’t. I always like to have as much of a cushion as I can,” he said.

Risks worldwide

Geopolitical tensions can easily disrupt market dynamics when it comes to oil, he said.

“There are many risks associated with oil, and geopolitical events are certainly one of them,” he said.

For some, the unpredictability associated with geopolitical events is a deal-breaker.

A financial adviser said he avoids oil bets altogether and therefore will not buy notes linked to this commodity whether the performance is tied to spot or futures prices.

“Who knows what the price of oil is going to be? Oil is a global political football,” he said.

Target return

Jonathan Tiemann, president of Tiemann Investment Advisors, said the note was attractive for investors seeking a specific, predetermined return.

“11.63% is not a bad-looking return over 13 months. I guess it’s for someone looking for a target return and willing to take on some risk on the downside,” he said.

Whoever bought the note was probably not making a bet on oil, he added.

“It’s more of a play on volatility. You’re selling volatility, and there is plenty of volatility in oil prices. That’s how you get the double-digit return.”

Negative prices

Was the 40% barrier sufficient? Tiemann was unsure.

“In a way, it looks like it’s a deep enough barrier. But you have to remember how volatile oil prices can be.

“Remember 2020 at the beginning of the pandemic? The prices of oil futures contracts turned negative as global demand plummeted.”

He explained why.

“Prices at the time indicated that at expiration, holders of long futures contracts positions preferred to pay someone to take the commodity off their hands rather than taking delivery,” he said.

The negative prices at the time represented an “anomaly,” which was the result of a “deep” recession, he said.

“I don’t know if a future recession could get that deep. I doubt it.”

Bothersome cliffs

Tiemann said he understood why the digital payout of the notes would be compelling for investors. But he would not consider the security for his clients.

“I think buyers look at it relative to other one-year instruments. Getting almost 12% is so much higher than what you can get from a high-yield corporate, or a Treasury.

“But I don’t know that I would want to put a client in this,” he said.

For one thing, Tiemann said he does not follow the oil market.

But the barrier was the main drawback.

“Those cliffs always bother me a little. There isn’t much of a difference between a 39.9% drop and 41.1%.

“It looks like 40% is a conservative protection level. But I’m not sure it really is given the asset class. I still think there is too big of a risk in a 40% barrier. Oil can move under many different circumstances – a recession, a supply shock, a demand offset by alternative sources of energy. It’s highly volatile; so, I wouldn’t want to take that bet.”

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

The notes settled on Monday.

The Cusip number is 90289X449.

The fee is 2%.

© 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.