JPMorgan’s $2.3 million digital barrier notes on Carnival to offer alpha potential, Covid risk

By Emma Trincal

New York, Aug. 18 – JPMorgan Chase Financial Co. LLC’s $2.3 million of 0% digital contingent buffered notes due Aug. 24, 2022 linked to the stock of Carnival Corp. provide a wide range of opportunities to outperform the stock given the low barrier strike and high digital payout.

The risk is commensurate with the potential return, however. In buying the notes, investors are betting on an industry devastated by the coronavirus pandemic and now threatened by the spread of the Delta variant.

If the stock gains, finishes flat or falls by up to 40%, the payout at maturity will be par plus 14.5%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will be exposed to the stock’s decline from its initial level.

Staying afloat

The large cruise line operator has suffered heavy losses in revenues and cash flow as a result of the Covid-19 outbreak, the company said in its late July earnings report.

The report also disclosed the company’s struggle to raise cash in order to fund its operations.

One major challenge posed by the Covid-19 outbreak is its effect on the ability or desire of people to book cruise trips, the company stated.

The stock closed at $22.48 on Wednesday, or 57% lower than its level in January 2020 prior to the Covid selloff.

The company’s debt is rated B with negative outlook by S&P Global Ratings.

Heads or tails

“The terms reflect the junk bond rating in my view,” a buysider said.

“It’s a digital bet with a high coupon. But the coupon is high for a reason. This is a company struggling to survive.”

Even with a deep strike at 60% of the initial level, the terms, and the yield “don’t seem so outlandish,” said this buysider.

“The driver on this thing is the volatility for sure.”

The implied volatility of the stock is 62.84% compared to 21.7% for the S&P 500 index.

“With the drag the Delta variant is going to have on their business, your digital bet is not so much on the coupon but rather on the company’s solvency. Solvent or not solvent...that’s the digital bet I think.”

Bullet

Another factor likely to have boosted the yield was the choice of a non-callable structure.

“Digitals tend to pay a higher coupon because the outcome is more extreme.”

The “outcome” at maturity, he explained, is between an annualized return of 14.5% and a loss of at least 40% of principal, possibly 100%.

Barrier, entry price

A financial adviser had a different view.

“It seems like a pretty good deal to me. 40% gives you a lot of leeway on the downside and one-year is a reasonable time period,” he said.

Another advantage was the current stock valuation.

The stock is 70% off its multi-year high of January 2018.

“You’re buying at a decent level, which is always preferable, especially if you add the 40% protection,” he said.

“It’s not rock bottom like last year after the Covid sell-off we had in the spring. But it’s not overvalued. It’s also untrendy because of the coronavirus. These things are positive things.

“The 40% protection is reasonable. But whether it’s enough I don’t know. If we were to see a big drop like last year, you’d be looking at much more than a 40% decline.”

The share price was as low as $7.80 at the end of April 2020. Revisiting this level would cut the current stock price by nearly two-thirds.

The one-year term played to the advantage of investors giving the price enough time to stabilize, he added.

“One year from now, a number of stocks and sectors will have gone through some kinds of ups and downs. I think the term is reasonable here,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on Aug. 12.

The Cusip number is 48132WAX7.

The fee is 1%.

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