JPMorgan’s dual directional review notes on oil index have ‘healthy’ barrier in risky trade

By Emma Trincal

New York, Aug. 11 – JPMorgan Chase & Co.’s 0% dual directional buffered review notes due Aug. 30, 2016 linked to the S&P GSCI Crude Oil Index Excess Return are not designed for everyone given the current bear market in oil, buysiders said.

But for investors who have an informed view on the commodity, the amount of protection and the absolute return feature offer attractive rewards for the risk incurred, they said.

The notes will be called at par plus at least 15.25% per year if the index closes at or above its initial level on any quarterly review date, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called and the final index level is less than the initial index level by up to 30%, the payout at maturity will be par plus the absolute value of the index return. Otherwise, investors will be fully exposed to the index’s decline from its initial level.

Speculative play

“It’s a bet on oil prices. For someone who has a view on the commodity, it’s a healthy barrier. As long as crude oil trades at above $30 a barrel, you’re in a good shape,” said Tom Balcom, founder of 1650 Wealth Management.

The index tracks the price of West Texas Intermediate oil contracts.

WTI crude oil for September delivery settled at $43.08 per barrel on Tuesday. Seventy percent of that price would be roughly $30.

“If your view is that a year from now, oil will be above $30 a barrel, if your call is correct, it’s a great return,” he said.

But Balcom showed some caution.

“This investment is not for everyone. It would be for a client intimately familiar with the price of oil. I would want to make sure the client has serious knowledge of the commodity,” he said.

“For the retail investor, it’s a speculative play on oil, which is fine if they realize it.”

Headwinds

While the barrier is attractive, any position in the note would have to be limited in size.

“The 30% protection is nice for someone who wants to bet that it won’t drop any further than that. But I wouldn’t bet the ranch on this,” he said.

Because of the cap, the notes would only fit a sideways or mildly bullish view.

“If you’re bullish, you might want to buy oil outright. But this deal gives you plenty of leeway if you’re wrong.”

Balcom said that he would probably not buy the note for himself.

“I’m more pessimistic about oil. We have this excess supply problem. Iran could flood the markets with more oil,” he said.

“And there is this fear that China’s economy is slowing. We saw today China devaluating its currency. It’s not good news for oil since China is the largest energy consumer in the world.

“But if you’re not bearish on oil, if you think that oil has dropped so much already it can only rebound, then the notes offer a great opportunity to monetize your view.”

Already low

A buysider said the notes are a good fit for a technical investor who believes that oil will trade sideways over the next year. He likes the risk-reward profile.

“It’s almost odd to me because I don’t really see what you’re giving up in this note,” he said.

“On the upside you can make 3.8% per quarter. It’s very likely that it’s going to happen on the first call date. A 3.8% return after just three months with your money back is really not a bad outcome.

“Oil is a commodity. You’re not giving up any dividends. Plus, you’re making money on the downside up to a 30% decline.”

The odds of making money are good given today’s valuations.

“Oil right now is at $44. You would have to see the price drop to $31 a barrel. That’s pretty low in the grand scheme of things,” he said

Range bound

“I would probably put a position based on some sort of trading range because I think from a technical perspective, which is how many commodities investors operate, you’ll see the action between a $42 or $43 and $60. These are your support and resistance levels,” he said.

“It seems like a good deal to me because oil is going to trade in a range for some time. I can see oil prices being in a situation similar to metals prices. The price of gold was very high until it crashed. Then it stayed low for a long time. Oil will stay low for a while too. I don’t see oil going back up to new highs. But I don’t see it crashing either.

“This deal is likely to give investors 3.8% on the first quarter. That would be my forecast. I’m not really sure it’s going to break outside the trading range.

“One way or the other, as an investor, you’re really enjoying a lot of protection.”

J.P. Morgan Securities LLC is the agent.

The notes are expected to price on Aug. 21 and settle on Aug. 26.

The Cusip number is 48125UL34.

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