JPMorgan’s capped buffered leveraged notes linked to FTSE 100 aimed at short-term U.K. bulls

By Emma Trincal

New York, Oct. 19 – JPMorgan Chase Financial Co. LLC’s 0% capped buffered return enhanced notes due Dec. 4, 2017 linked to the FTSE 100 index are designed for investors who are betting on a continued U.K. equity market rally, at least for a short time horizon, sources said.

The payout at maturity will be par plus 1.5 times any index gain, up to a maximum settlement of $1,151.50 per $1,000 of notes, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will lose 1.1111% for each 1% decline beyond 10%.

The notes will be guaranteed by JPMorgan Chase & Co.

Bullish

Looking at the 15.15% cap, a market participant said, “Not bad for a 13-month. FTSE is a very popular index right now. It had a huge run even with Brexit.”

The FTSE 100 is the United Kingdom’s large-cap benchmark tracking the price of the country’s 100 largest companies listed on the London Stock Exchange.

Since its prior low at the end of June during the U.K. vote on exiting the European Union, or “Brexit,” the index has appreciated by more than 17%. Since Brexit as well, the British pound has plummeted. Analysts said the U.K. equity rally is in large part the consequence of the depreciated currency.

With a nearly 14% annualized compounded return for a cap, the notes target bullish investors who may want to join the rally bandwagon, the market participant said.

“If you want exposure to the U.K., it’s a good way to do it,” he said.

Geared buffer

But the gearing on the downside is not likely to appeal to the average individual investor, he noted.

“Anytime you see accelerated downside, it’s kind of scary. People don’t always realize how much it allows you to get better terms. I would imagine it would be institutions rather than retail clients using that type of buffer. ... Taking that kind of accelerated loss is more geared towards QIB or private wealth clients.”

The acronym QIB stands for qualified institutional buyer.

“When market losses are already bad and clients have to stomach even more losses, it’s kind of tough.”

But in reality, the benefits of a geared buffer are significant and contribute to a “very decent cap,” for this note. While retail clients want traditional buffers, their benefits compared to geared buffers are comparatively small, he noted.

For instance, if the FTSE 100 index were to drop 30%, investors in the notes would lose 22.22% versus a 20% loss for investors in the same note but with a straight 10% buffer.

“But for retail, risk has less to do with the actual risk than with the headline risk.”

Too rich

Steven Jon Kaplan, founder of TrueContrarian Investments, emphasized the risk associated with the underlying investment theme. He is skeptical about the probabilities of the U.K. equity market rally lasting much longer.

“I don't like this underlying too much because the FTSE 100 has become inflated due to the very weak British pound, which itself has to do with irrational Brexit fears,” Kaplan said.

“The FTSE 100 index is therefore just as vulnerable to a decline as the S&P 500, and perhaps even more so due to its significant gains in recent months.

“Probably we won't have a huge bear market in 13 months, but I don't think the upside is very promising.”

Pound bull

The British pound and the FTSE 100 have moved in opposite directions.

“This [stock] rally is faked. I wouldn’t want to bet on more increase in the index because the pound at some point is going to rebound,” he said.

“One thing I do like is the British pound itself. If the notes were tied to the exchange rate between the pound and the U.S. dollar, with gains if the pound climbs higher, then I would heartily endorse it.”

For now, the British currency continues to depreciate, reflecting new fears about the acceleration of the U.K. exit from the European Union, although the downtrend has fluctuated of late. On Wednesday, the currency closed at 1.2277 against the dollar. It was at 1.48 in June just before Brexit.

The notes hedge the currency risk, according to the prospectus, which stated that the value of the notes will not be affected by changes in exchange rates. However, the impact of the British pound’s depreciation is likely to drive up the value of the FTSE 100.

But for Kaplan, the British pound may be close to bottoming.

“I can easily see the pound moving back up to $1.50 within two years or less. And that would easily translate into the 11% loss in the index which is the cutoff for the notes,” he said.

“I think the timing for being bullish on the U.K. stock market right now is not best. This is a trade that should have been put on when they voted on Brexit in June.”

J.P. Morgan Securities LLC is the agent.

The notes (Cusip: 46646EZ47) will price on Oct. 21 and settle on Oct. 26.

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