Pricing Structured Products Around Oil

Lately, we have been working hard to develop high coupon auto calls based on the price of oil. Creating auto call notes on commodities is difficult, if not impossible, as the commodity indexes do not follow the spot price of the commodity due to contango in the futures term structures. None of the details of why this occurs are important to most investors, so lets get to what does matter.

If we cannot create auto calls on oil directly or on ETFs like USO, we can try and price them on oil related stocks or on ETFs that invest in oil related stocks, such as OIH or even XLE. This is what we are working on currently.

So far this is the pricing we have from a AA- rated bank:
· 5 years term
· GBP
· Basket of XLE, FTSE 100 and S&P 500
· Semi-annual observations
· 100% autocall trigger
· 50% European barrier
· Snowball coupon
· 7% per annum coupon
If the European barrier is increased to 60% the coupon rises to 8% per annum. Still, this is not very enticing!

This does compare with another product that we have seen being discussed actively, including recently on our own Structured Products page, that uses the Excess Return Oil Index (which does a lousy job of tracking oil spot prices) with a 50% American barrier (which we would not recommend) yielding a coupon of 9% per annum. Again, neither of these products “shoot the lights out”, but using an index of stocks rather than a commodity index has big impact on reducing volatility (and therefore returns).

If 8-9% annual returns are just too low, lets discuss what pricing is interesting in relation to some current products available.

One structured product marketed currently is an income note with a 9% annual coupon over 1 year on a basket of Repsol, Halliburton, Gazprom and Chesapeake Energy. We are not big fans of the the basket, but we have priced this product with a much higher 14.4% annual return with a better rated bank! An autocall on the same basket over 2 years would offer 25.5% per annum. The product would autocall quarterly as long as no basket members have fallen by 20% or more. This '80% or more corridor' is truly massive for an auto call note and is worthy of investors' attention.

Author: Chris Davies

Posted in: auto call , oil , structured products , USO , XLE