JPMorgan’s jump autocallables linked to CAC 40, FTSE MIB, IBEX 35 offer rare European angle

By Emma Trincal

New York, Sept. 26 – JPMorgan Chase Financial Co. LLC’s 0% jump securities with autocallable feature due Oct. 1, 2020 give investors a different and more concentrated approach to European exposure, buysiders noted. Instead of being linked to the Euro Stoxx 50 index, which is employed in nearly all structured notes on Europe, they are linked to the worst performing of the CAC 40 index, the FTSE MIB index and the IBEX 35 index.

The CAC 40 tracks the performance of the 40 largest and most actively traded shares listed on Euronext Paris. The FTSE MIB measures the return of 40 stocks listed on the Borsa Italiana. The IBEX 35 tracks the 35 most liquid stocks on the Spanish stock exchange.

Pure autocall

The structure does not offer a contingent coupon; investors get paid when the notes are automatically called, according to a 424B2 filing with the Securities and Exchange Commission.

The automatic call occurs at par of $10 plus a call premium if each index closes at or above its initial level on either annual call observation date. The call premium is expected to be at least 10% per year and will be set at pricing.

If each index finishes at or above its downside threshold level, 70% of its initial level, the payout at maturity will be the maturity redemption payment, which is expected to be $13 per $10 principal amount of notes and will be set at pricing. If the final level of any index is less than its downside threshold level, investors will lose 1% for every 1% that the worst-performing index declines from its initial level.

Three-year scenario

Ideally, the best scenario would be no autocall until the third observation date, said Kirk Chisholm, financial adviser at Innovative Advisory Group.

“It would trade slightly down and then at the end of the third year the three indexes would pop up. It’s unlikely. You’re much more likely to get called,” he said.

Chisholm stressed the risk of limited upside, noting that the asset class should generate more than the offered premium.

Cap

“If I’m going to invest in Europe, I have no intention of capping myself. They give you 10%, which is nice, but it’s not huge.”

But his main criticism was of the worst-of feature.

“While I can understand why some people would do that for the premium, I don’t like this because of the worst-of component. It’s certainly not an easy thing to sell to a client because nobody wants the worst of anything.”

Chisholm said that instead of the notes, he would substitute a buy-write strategy, which consists of being long the underlying and selling a call option against the position to generate a premium.

“I would create covered calls for my clients. It’s not so complicated. I would go much shorter. If I’m called up after one year, I just write another call, and I can do that three years in a row,” he said.

In-between category

Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments, commented on the choice of the underlying indexes.

“It’s an interesting mix of indices. They’re moderately correlated, which is good. When you think of Europe though, you think immediately about Germany, the U.K. and maybe Switzerland. France, Italy and Spain are sort of in the middle. They’re not the top tier, but they’re not on the riskiest end either like Greece.”

Kaplan did not have any real objection to the call premium amount. As a contrarian, he said he is increasingly skeptical about the resilience of the European bull market. In fact, his view has turned bearish as he predicts a global downtrend starting in the United States.

Bearish outlook

“I don’t think the timing is right. A couple of years from now, we’ll see European markets drop. I believe we’ve already started a bear market in the U.S., which will have an impact on Europe as well,” he said.

Kaplan said that too much momentum has built up around European markets this year, making the asset class, once seen as a good play on a valuation basis, vulnerable to a trend reversal. The Euro Stoxx 50 index is up 21% since the beginning of the year versus about 12% for the S&P 500 index.

“Two years ago, Europe was a bargain. I think the 2016 bargains are now gone. Everybody is buying Europe. It’s an overcrowded trade,” he said.

Relative value

To be sure, the three underliers used in the notes have underperformed the broader benchmark. The FTSE MIB has gained 14.65% for the year while both the CAC 40 and the IBEX 35 are up about 7.5%.

“On a relative basis, these three countries are still offering some value, and perhaps that’s one of the selling points of this deal. But on an absolute basis, they remain quite high, and they will be caught up in the overall decline,” he said.

The three-year tenor could be beneficial to investors if the bear market ends soon enough to give room for a recovery. But the trade is still too risky, he said.

“You could get a 50% to 60% bear market in two years and then a rebound, but we could still have one index down more than 30%. The market does not always necessarily go back up in a predictable way.

“The downside risk in this note is the most serious risk here ... more serious than the cap.”

The notes will be guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the underwriter. Distribution is through Morgan Stanley Wealth Management.

The notes will settle on Friday.

The Cusip number is 48129J418.

© 2015 Prospect News.
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