JPMorgan’s leveraged notes linked to FTSE 100 bet on uncertainty around pound sterling, Brexit

By Emma Trincal

New York, Oct. 25 – JPMorgan Chase Financial Co. LLC’s 0% capped buffered return enhanced notes due Oct. 31, 2018 linked to the FTSE 100 index offer an attractive risk/reward profile for investors willing to take risks on the weakening of the British pound and the economic consequences of Brexit, financial advisers said.

The payout at maturity will be par plus double any index gain, up to a maximum return of 30% to 34% that will be set at pricing, 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% for each 1% decline beyond 10%.

Contrarian

“It’s a very interesting play in terms of the doom and gloom around Brexit,” said Elliot Noma, founder of Garrett Asset Management.

“It’s definitely a contrarian view.

“The upside looks pretty good if you think the negotiations between the U.K. and the European Union will go well.”

The term “Brexit” refers to the U.K.’s decision to leave the European Union made during a vote in June. Prime Minister Theresa May announced that she wants to initiate the implementation by March. Since the vote, the British currency has lost 18% of its value against the dollar. Earlier this month, the pound went through a flash crash but has regained some value over the past two weeks.

Analysts have said that the weaker pound has helped fuel a rally in the U.K. stock market because British exporters bring more revenue in pounds.

Plummeting pound

“The pound has been slaughtered since Brexit. There are a lot of jitters around the pound right now,” said Noma.

While the depreciation of the currency may help equity prices, it is sure to hurt investors in the notes as the structure is not hedged against currency risk, according to the prospectus.

The prices of the FTSE 100 components will be converted into dollars. If the pound weakens against the dollar, investors in the notes will see their payout reduced, the prospectus warned.

“The weaker pound is helping British exports. ... I think it’s the compensation right now. But the real question is not the pound. The real question is, what will be the business conditions after Brexit?” said Noma.

“If they really implement it, some British companies may be looking for the exits and try to relocate in Paris or Frankfort.”

Economic impact

“A real Brexit would mean that U.K. companies would have to trade country to country. It would be an additional regulatory barrier,” he said.

“There is a maneuvering right now going on between the U.K. and the E.U. The British obviously want to keep ties with the E.U., but the E.U. may not want to set a precedent and see other countries leaving the union as well.”

Noma said that the strong rally in the FTSE 100 does not mean anything.

“Nothing has really happened yet. Some may be buying because the market is cheap.

“Of course there is risk, but there is risk in everything.

“In order to buy this, you have to be betting that the Brexit negotiations will go very well. If that’s your view, this gives you a very nice package to express it.”

Currency risk

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, looked at the current valuations of the U.K. benchmark as well as the pound and questioned the timing of the trade.

“I would look at it as a play around the currency,” he said.

“The pound has already dropped a lot. Will it drop more, or will it go back up?”

If the pound continues to depreciate against the dollar, investors in the notes will incur losses due to the conversion of the securities into a stronger currency, he said.

If the pound were to rebound, the implications on the FTSE 100 index price would be unknown as various factors would be at play.

“This currency depreciation may drive the equity price, but for how long?” he said.

“The currency has already dropped significantly. The FTSE is already in its higher range if you look at the long-term chart.”

Rich

On Oct. 11, the FTSE 100 hit an all-time high at 7,129.83.

Chisholm said the trade involves too many unknown factors, such as the implementation of the Brexit vote, the movement of the British pound and the relationship between the pound and equity prices.

“Ultimately, the main uncertainty is Brexit. Until things are ironed out, you have no idea how things are going to impact the market,” he said.

“Until negotiations really start, it’s hard to make an educated guess. I’m not in the profession of making guesses with investors.

“You don’t have to invest everywhere. This particular market is a place I would ignore.

“If it was cheap, it may be a different story. But the FTSE 100 stock index is expensive, and there are a lot of risks. That’s a bad combination.”

The notes will be guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will price on Wednesday and settle on Monday.

The Cusip number is 46646EM25.

© 2015 Prospect News.
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