JPMorgan’s uncapped dual directional leveraged notes on indexes introduce novel double barrier

By Emma Trincal

New York, Sept. 29 – JPMorgan Chase Financial Co. LLC’s 0% uncapped dual directional accelerated barrier notes due Oct. 1, 2026 linked to the least performing of the S&P 500 index, the Nasdaq-100 index and the Dow Jones industrial average present an innovative structure with a double set of barriers allowing for downside protection and absolute return gains at different levels, in an overall effort to increase the amount of protection and uncap the return on the upside.

The payout at maturity will be par plus 1.28 times the gain of the worst performer, if all indexes finish above their initial levels, according to a 424B2 filed with the Securities and Exchange Commission.

If any index falls but each index finishes at or above its absolute return barrier, 70% of its initial level, the payout will be par plus half of the absolute value of the least performing index return.

If any index falls below the absolute barrier but each index finishes at or above its barrier amount, 60% of its initial level, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline of the worst performing index from its initial level.

Creative enough

“You’re covering the worst-case scenario, which is down 40%,” a financial adviser said.

“The absolute return is 50%. But at least you get money for a decline of up to 30% and that’s huge. The index is down 30%, you make +15%.”

While elegant, the structure may also hide a “gimmicky aspect,” he noted.

“What are the odds you’re going to be in that range, down 30% or 40% in five years? I don’t have the back-testing data. But I would give it a 2% probability.”

Overall, halving the downside participation within the absolute return range was the adequate answer to a pricing dilemma, he said.

“It’s creative though. We know that 100% absolute return kills your barrier and your leverage.

“You go with 50% absolute return and the terms are much better. It’s great.

“I would try to reduce the size of the barrier for the absolute return. Perhaps 20% and get more leverage on that note.”

Five-year term

Some advisers feel comfortable enough with longer-dated notes such as this one to abandon the very need of downside protection.

“Not us,” he said.

“We want the protection even on a five year.”

But whether advisers seek a barrier or not, as well as how much of it, depends on how they organize their hedges.

“If you already have a hedge on your portfolio, you may not need the downside protection on a growth note. You may just want the horsepower. We want both. The horsepower and the hedge,” he said.

Customized trade

A structurer looked at the structure as the fruit of a dialogue between a client and the issuer. The double barrier was the most intriguing piece in his view.

“This is the kind of financial engineering you need to do to showcase a desired return,” he said.

“Obviously, someone came to the issuer asking for 40% in downside protection, uncapped exposure on the upside and absolute return on the downside.

“The answer came back – yes, we can do that, but we need to reduce the absolute return participation to 50% and give you a different barrier level for the absolute return.”

The combination of the two barriers – one for the protection and the other for the absolute return – was something he had never seen before.

“In Europe, I’ve seen issuers putting together a buffer and a barrier at different strikes. For instance, you get a 20% buffer or geared buffer and down to 30%, it’s a barrier. But I haven’t seen this technique applied to increase the range of absolute return,” he said.

Mature market

A sellsider said the structure spoke for the level of sophistication among structured notes investors.

“People like absolute return features. If the market is up, you get a positive return, and if it’s down, you still get something. Could they have done the absolute return with a 40% barrier? Probably not,” he said.

To overcome the cost issue, the bank made the absolute return feature less expensive in two ways – with the 50% participation and with the 30% barrier dedicated to the absolute return, he explained.

“That double barrier feature is very interesting...very innovative. I think it positively reflects on the market. People are more sophisticated in our industry. They know what they want. Here they’re getting a significant downside protection of 40% and the absolute return.”

Fee, entry point

The notes carry a 0.4% fee, according to the prospectus.

“That low fee suggests it probably was created for a large client, such as a family office.”

The notes were expected to price at the close of Tuesday, a bad day for the stock market. The three underlying – the Nasdaq-100, the S&P 500 and the Dow Jones industrial average – finished the day lower by 2.8%, 2.04% and 1.63%, respectively, amid concerns over rising interest rates.

“Good timing if the deal priced on Tuesday. Investors were able to get in at a better entry price,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes are expected to settle on Oct. 1.

The Cusip number is 48132WZH5.

© 2015 Prospect News.
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