JPMorgan's $41.84 million knock-out notes tied to S&P show demand for return floor, high cap

By Emma Trincal

New York, March 10 - JPMorgan Chase & Co.'s $41.84 million sale of index knock-out notes linked to the S&P 500 index reflects the popularity of structures that provide a high minimum return as long as the underlying index does not decline beyond the knock-out buffer, sources said.

The 0% notes are due Sept. 1, 2011, according to a 424B2 filing with the Securities and Exchange Commission.

A knock-out event occurs if the index ever falls by more than the knock-out buffer amount of 20% during the life of the notes.

If the index stays at or above the knock-out buffer, the payout at maturity will be par plus any index gain, with a contingent minimum return of 9.43% and up to a maximum return of 30%.

Otherwise, the payout will be par plus the index return, capped at 30% and with exposure to any losses.

Attractive minimum

"This is great. The S&P could end up down, [and] as long as you don't go down to 20%, you get at least the 9.43% return. That's a pretty good piece of paper for one-and-a-half years from now," said Jim Delaney, portfolio manager at Market Strategies Management in Township of Washington, N.J.

Still risky

The notes become risky if the underlying index declines by 20% or more at any time during the term, said a sellsider.

"This is an 18-month buffered return enhanced note with a 20% downside protection. You still have full downside exposure if the barrier ever gets hit. People do like the contingent minimum return, but they sometimes fail to see that their capital is entirely at risk," this sellsider said.

Bulls' leap

But Delaney said that the risk is worth taking for bullish investors.

Looking at the downside first, Delaney said he does not anticipate that the S&P 500 will post a 20% decline in the next 18 months.

"I see that in three or five years from now. But not in the short term," he said.

Delaney added that his perspective on U.S. equity is "bullish" because "I don't believe in a double-dip recession. As long as we keep adding jobs, even slowly, I think the worse is behind us. Mergers-and-acquisitions is back. Capital investment is back," he said.

"I think it would take a lot of work for the market to break another 20%," he added.

The S&P 500 closed at 1,139.00 on March 5 when the deal priced. Delaney said a 20% decline would put the S&P 500 level approximately back to the 879.13 level at which it closed during the last correction on July 10, 2009.

"I just don't see it happening now," he said.

Generous cap

On the upside, Delaney said the risk is that the index will outperform the cap, but he added that such risk is limited because 30% is a "generous cap."

Delaney said that during the course of last year, the S&P 500 rose by 23.5%.

"But that's not just that. From its low of 666 in March 6, 2009, the benchmark actually moved up by 68% from March to December. As much as I doubt that you're going to see a market dropping by 20% within a short amount of time, I also doubt that we're going to see stocks surging again by more than 30%. For the market to climb more than that at the end of 18 months would be a real acceleration. Everything is possible, but it's unlikely," he said.

JPMorgan distribution

JPMorgan Chase Bank, NA and J.P. Morgan Securities Inc. are the agents for this new offering.

Several other issuers have recently used JPMorgan's distribution network to sell similar deals, also using the S&P 500 benchmark as the underlying.

The sizes of those similar offerings suggest that the structure has been popular, sources said.

A couple of weeks ago, HSBC USA Inc. sold via JPMorgan $34.14 million of 0% knock-out buffer notes due Aug. 30, 2011 based on the S&P 500 index. The knock-out buffer was 20%, the cap was set at 30%, and there was a contingent minimum return of 10.4%.

The agent was J.P. Morgan Securities.

Also at the end of last month, Morgan Stanley priced $46.44 million of 0% knock-out notes due Sept. 1, 2011 linked to the S&P 500 index with a 20% buffer, a 30% cap and a contingent minimum return of 10.75%.

JPMorgan Chase Bank and J.P. Morgan Securities were the agents.

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