JPMorgan's contingent autocallables tied to Foot Locker offer non-directional return potential

By Emma Trincal

New York, Jan. 15 - JPMorgan Chase & Co.'s 0% contingent absolute return autocallable optimization securities due Jan. 27, 2014 linked to the common stock of Foot Locker, Inc. offer investors the opportunity to make money regardless of the direction of the stock, which makes the structure "attractive," said Dean Zayed, chief executive of Brookstone Capital Management.

With the combination of an autocallable feature and an absolute return payout, investors can earn up to 12% on the upside or 25% on the downside under certain conditions.

The notes will be called at par of $10 plus an annualized call premium of 9% to 12% if Foot Locker stock closes at or above the initial share price on any quarterly observation date. The exact call premium will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called and the final share price is greater than or equal to the trigger price, 75% of the initial share price, the payout at maturity will be par plus the absolute value of the stock return. Otherwise, investors will be fully exposed to the stock decline.

Having conviction

"Somebody would want to be intimately familiar with the stock. You would want to have some conviction about Foot Locker so that you can decide whether to be long the stock or get exposure through the notes," Zayed said.

"But the structure itself is very attractive. I like the absolute return a lot. I'm just not sure if I would want to enter a position in this particular stock."

Zayed said that he liked the absolute return payout because the downside barrier gave him some level of comfort.

"The absolute return has a lot of appeal, especially with a 25% buffer. It is scary that the stock is not far from its 52-week high, but there's a large enough buffer, and a one-year duration to me is short term," he said.

"It all boils down to having a conviction on the stock."

Foot Locker is a retailer of athletic footwear and apparel. At Tuesday's closing price of $34.05, the stock is not far from its 52-week high of $37.65. The 52-week low is $24.58. Recent performance has been strong; the share price is up 7.78% this year and nearly 38% for the past 12 months.

"I like the overall structure. But you really have to track the stock, the options and the volatility associated with the name," Zayed said.

Straddle

Jonathan Tiemann, founder and chief executive of Tiemann Investment Advisors, LLC, said that he was surprised about the choice of the underlying stock.

"Foot Locker has been around for a long time; it's not a completely unknown name. It's an athletic footwear retailer. But it's still a funny stock to do that trade on. You want to scratch your head and ask why they took this particular name," he said.

Tiemann said that the trade was designed to generate a positive return whether the stock would go up or down under certain conditions. But he saw the notes more geared toward the bearish investor than the bull given the higher potential gain coming from the absolute return feature than the call premium.

However, investors could still profit regardless of the direction of the stock as long as the share price remained in a range, a form of option strategy called a straddle, he said.

The absolute return feature can be reproduced with a put spread, he explained.

"You buy two at-the-money puts to create the absolute value payout. One put gives you the protection, the other the absolute value return.

"At the same time, you sell two puts at the 75 strike. This is what will turn the trade back to the stock performance once you hit the 75 strike price," he said.

On the upside, the trade is the equivalent of selling an at-the-money call. The call premium received by the investor is the equivalent of the premium one would receive on the call sale, he explained.

Bearish bias

Investors earn the call premium subject to certain limitations; for instance, the stock has to trade above its initial price on the observation date only.

In addition, bears get a better reward than bulls, he noted.

"You have to be a little bit bearish for this trade. I think the notes have a bearish bias even if you get compensated on the call. You don't believe that Foot Locker is going to continue to go up very much. Otherwise you would buy the stock without capping your upside. Your view is that the stock is overbought but that the valuation is not out of whack. If the stock goes up, you can still make money on the call. In fact getting called is not a bad outcome. You get called after six months and you make 6%. Not bad. But that's not why you would enter the trade in the first place," he said.

A bear on the other hand has the potential to earn 25%, or more than twice what the maximum call premium could be, he said.

"It's an alternative to shorting the stock. You make money if the stock declines by less than 25%. After that, you're long the stock. With a short, you would make money all the way down. So that's different," he said.

"But the trade-off is that unlike a short, you can also make money on the upside.

"I guess it's a bit safer than just being short the stock because you can make money on both sides of the trade.

"At the end, what you are doing is sort of selling volatility."

The notes are expected to price Friday and settle Jan. 24.

UBS Financial Services Inc. and J.P. Morgan Securities LLC are the agents.

The Cusip number is 48126E347.

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