Size of JPMorgan's $48.64 million delta one structure linked to stock basket seen as intriguing

By Emma Trincal

New York, April 9 - The relatively large size of a repeat deal by JPMorgan Chase & Co. linked to a basket of stocks surprised some market participants for the deal's cost and lack of optionality. But they reasoned that access to a diversified stock portfolio for smaller accounts and simplicity may explain the popularity of the deal.

JPMorgan priced $48.64 million of 0% return notes due April 22, 2015 linked to the common stocks of AMC Networks Inc., Bed Bath & Beyond Inc., BioMarin Pharmaceutical Inc., Endo Health Solutions, First Republic Bank, HomeAway, Inc., Insulet Corp., Lions Gate Entertainment Corp., Mylan Inc., Qlik Technologies Inc., Rackspace Hosting, Inc., Rowan Cos. plc, Splunk Inc., Tenneco Inc., Trulia, Inc., Viacom Inc. and Weatherford International Ltd.

The stocks are equally weighted in the basket, according to a 424B2 filing with the Securities and Exchange Commission.

For each $1,000 principal amount of notes, the payout at maturity will be (a) $1,000 multiplied by (b) one plus the basket return multiplied by (c) a basket adjustment factor of 99%. Because of the basket adjustment factor, investors will lose some or all of their principal if the basket return is less than 1.01%.

The final basket level will be the average of the basket's closing levels on the five trading days ending April 17, 2015.

J.P. Morgan Securities LLC was the agent. The deal carried a 75 basis points fee.

'Weird'

"I spent time in the options pit. I see that deal as a sell. I don't really get that at all," a structurer said.

"It's a short-term delta one allocation for someone who wants to buy a basket of stocks. But it doesn't come cheap."

A sellsider agreed.

"No cap, no optionality, no floor, no leverage. It's weird. Why not buying the stocks? You'd think JPMorgan would let its clients access stocks pretty cheaply," this sellsider said.

Investors in the notes are not entitled to receive dividends from any of the reference stocks, according to the prospectus.

"Investors in the notes are buying the stocks and they're foregoing the dividends. Usually you do that to get a buffer or some form of optionality. But you don't have any of that here. It's strange, isn't it?"

The loss of dividends may not be a real concern, a source noted, because the majority of the stocks composing the basket do not pay dividends.

The highest yielding component is Viacom with a dividend yield of 1.43%. Two other stocks pay dividend yields of less than 1%.

Fees

"I think it's expensive regardless of the dividends. The issuer gets 1% in adjustment fee, and the agent on top of that is getting a 75 basis points commission. And it's a pure tracker, a one-to-one," the sellsider said.

"Look, imagine you're an individual investor who wants to buy the shares by yourself. Let's say your broker charges you a $10 commission per trade. Imagine the average security you buy trades for $50 a share. You buy 100 shares of each stock, or $5,000 per name. Your cost is 20 basis points. It's obviously cheaper to do it yourself."

Recurrent offering

What was even more intriguing for sources was the fact that JPMorgan has been offering the same deal at least twice this year and is prepping a new one this week.

At the end of March, JPMorgan priced $52.1 million of 0% return notes due April 15, 2015 linked to the same basket of 17 stocks, according to a 424B2 filing with the SEC.

The notes (Cusip: 48127DCT3) carried the same fee structure and offered the same terms.

In addition, JPMorgan plans to price on Friday the same deal again in a new issue of 0% return notes due April 29, 2015 linked to the same basket of stocks, according to an FWP filing with the SEC.

The notes (Cusip: 48127DEH7) offer the same terms.

"The fact that they repeat the deal with the same stocks almost each month makes me think that it's a deal between JPMorgan and an RIA," the structurer said.

"I don't know who exactly would select the stocks, if it's JPMorgan's brokerage arm or the client himself, but chances are they do it month after month, and maybe they change the allocation every quarter, I'm not sure.

"Maybe they picked those stocks because they have enough non-correlation, which helps with the pricing even though the stocks individually are volatile.

"But when you think that it has a 1% back-end fee plus 75 basis points in brokerage commission ... for a delta one, it's kind of expensive."

The top sector allocation within the basket is consumer cyclical with five stocks. Technology and health care include four stocks each. Two stocks were allocated to financials and two to energy.

Access for all

"I think this is a pure access play for small investors," the sellsider said.

"The only reason you would want to do it is if you had a limited amount of money to invest."

In his example, an investor purchasing 100 shares of 17 different stocks with an average share price of $50 a share would need to put to work $85,000.

"This note allows you to do that with less," he said.

The minimum denomination for the deal is $10,000 with additional multiples of $1,000, according to the prospectus.

"Size to me would be the only valid reason. It's designed to trade a basket of stocks in a small way. Still, it's an expensive way to get that exposure," he said.

"I would want to look at the merits. The positive aspect of the deal is to give you exposure to a diversified basket of stocks, which hopefully would beat the benchmark. The negative is the cost and the fact that you're not getting any optionality.

"Investors have to make their own decision."

Compliance friendly

The structurer brought up a different reason than size, invoking simplicity.

"I can see one possible explanation for anyone to be interested in this: simplicity and compliance," he said.

"The concept of a non-complex product may appeal to some investors or brokers. This is who it might be suitable for.

"These days, with Finra's concerns over complex products, some brokerage clients may want something that provides diversification without complexity. And here you have it: there is no leverage, no buffer. This is not a complex product, obviously.

"Simplicity also helps advisers tell a story. If you do the same deal month after month, you do not need to spend much time educating. People understand it.

"Finally, it may be used as an overlay on top of an ETF portfolio to add a little bit of spice."

This structurer said that it was "hard to tell" if the notes were sold to one or several clients.

"Since the basket is identical each month, it's probably the same client or someone who saw the trade before and wanted to jump in. It could be one client. It could be two. But you have to be comfortable with those stocks, and it's not impossible that the client himself may have come up with the picks. Whoever did it was probably attracted by the simplicity of the deal. This deal is a way of distributing structured notes without the complexity."

The notes (Cusip: 48127DDQ8) priced on April 4.

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