Structured products based on oil are offered in all shapes and sizes, but what is on offer may not be enough to provide returns given the latest fall in oil prices, which took the price of WTI below US$40 a barrel on August 21, its lowest level since March 3, 2009. “Things are just too volatile today for most people to be wanting to trade in either direction,” said a commodity specialist in a structured products team at a European bank in London. “Investors have been trying to buy the dip in oil throughout this year, but most currently seem to be waiting to let the fall play itself out after being burned before. There is rarely a lot of interest in playing the short side.”
The news of the dip in WTI may yet prove, once again, to be a good entry point for investors. In line with this prognosis, Commerzbank is promoting an 18-month autocall (with call enhancement) based on the price of WTI via S&P’s GSCI Crude Oil Index with a valuation date of August 15 with a quarterly coupon of 12% pa and a 75% (European) put barrier. The fall in WTI will support prices once again, making the call enhancement feature an attractive addition to a traditional autocall whilst vanilla call options are expensive due to the high oil volatility (~41%), said Commerzbank.
Many pension funds seemed to be using this dip as a chance to get in, according to Jodie Gunzberg (pictured), global head of commodities at S&P Dow Jones Indices. “You can get a large inflation protection for a small allocation to commodities: the inflation beta is pretty high, at around 15… As the oil price has been falling, a lot of investors have been sitting on the sidelines waiting for inflation protection or diversification,” said Gunzberg.
“When including rolling costs of futures contracts, the index level of crude oil is at its lowest since October 1999, before detailing the negative factors that suggest the trend of falling oil prices is here to stay,” said Gunzberg. “The rolling costs are now only half of what it was in 2008-2009, and may be negative for an extended period, like after the global financial crisis. Then, it took excess inventories around six years to deplete and show significant backwardation.”
Those bankers dealing with hedgers are seeing demand from energy consumers, which clearly do not expect energy prices to remain this low for a long period. On the equity side, there has been demand for transport company shares (notably airlines), some of the chief beneficiaries of cheap energy prices. “When oil is hurting, it’s generally good for stocks, and vice versa,” said Gunzberg. “One of the problems is that normally when commodity prices fall it’s good for consumers. But this time it is not the case. Gasoline has held its price – normally it falls one for one - as, say, labour prices increase.”
Due to a better understanding of contango and backwardation, commodities have become an easier investment, according to Gunzberg. “Many structured products today have techniques to minimise contango,” she said. “The most simple is to shift forward static to three months out in the curve. Today, a lot of people use this for spread plays, going long six months and short two months. The next most simple is enhanced, which measures the contango at the front of the curve and it’s the first half of the year and there is contango, the index will go to the December contract.
A dynamic roll is the most fancy technique, which measures the implied roll yield of all adjacent liquid contracts out to 48 months on a month to month basis, and is able to pick off the optimal spot on the curve.”
The largest portion of structured products linked to oil issued this year have been linked to S&P DJI’s excess return version of its oil benchmark index. “The excess return counts the roll yield, which counts the return from selling out of the expiring contract and going into the new one,” said Gunzberg. “A lot of products use it because they manage the collateral separately, or maybe they are not investing in a T-bill, which is used by the total return index. It’s just a collateral yield difference between the excess and total return indexes.”
A number of this year’s deals linked to the S&P GSCI crude oil index have been created with barriers that allow for a fall in the price without a loss to capital: for instance, BNP Paribas was the provider for a deal distributed by subsidiary BNL in Italy in April that included a 70% barrier but locks in an annual coupon of 3.7% for the term should the index go above 110% of its initial level over the four-year life of the investment, according to SRP data.
Related stories:
Drop in commodities hits South Korea knockouts
Americas sales down on interest rate uncertainty and declining oil and commodity prices