JPMorgan’s $1.25 million digital on indexes to fit bearish, range bound outlook

By Emma Trincal

New York, June 1 – JPMorgan Chase Financial Co. LLC’s $1.25 million of 0% uncapped dual directional digital barrier notes due May 25, 2028 linked to the Dow Jones industrial average, Russell 2000 index and S&P 500 index should match a wide range of market outlooks including bearish and range bound but certainly not bullish, advisers said.

If the worst-performing index gains, the payout will be par plus the greater of that index’s return and the 43% digital payment, according to a 424B2 filing with the Securities and Exchange Commission.

The payout will be par plus the absolute value of the worst-performing index return if the worst-performing index declines but finishes at or above its 65% barrier.

Otherwise, investors will lose 1% for every 1% that the worst-performing index declines from the initial level.

Extreme barrier

Steve Doucette, financial adviser at Proctor Financial, said he would prefer notes with higher upside potential.

“This is being sold to people who are bearish and willing to lock in their money for five years to grab a 43% return. That’s about 7% compounded. Nothing that exciting,” he said.

The barrier may be oversized.

“Five years out, I can’t imagine the market being down more than 35% even if we go through two cycles by then,” he said.

The structure may also be appropriate for investors foreseeing a sideways market.

“If the market hasn’t done anything, you might catch some upside,” he said.

“It’s got to be for someone really concerned about the stock market. The only way to outperform is if it’s up a little bit or down above the barrier.

“It may pay off; it may not.”

Worst-of, long-term hold

Over a five-year term, Doucette said he was more inclined to be bullish.

In addition to not meeting his view, the note did not offer a predictable exposure.

“Even if it does pay off, you’re only getting the worst-of performance and you’re locking yourself in for five years. It eliminates your opportunity to rebalance,” he said.

Perhaps the protection made the structure slightly unbalanced.

“We spend a lot of time in these notes looking for protection. If it hits at the wrong time, it has no value. That huge barrier is really for the client’s peace of mind.

“I just can’t get excited about this note,” he said.

0.1% chance

A financial adviser agreed about the bearish nature of the product. But for some clients, it was the right investment, he said.

Looking at performance data on the S&P 500 index going all the way back to 1950, he found that the chances of breaching the barrier over a five-year rolling period was only 0.1%.

“It has happened in the last 72 years, but it’s extremely, extremely rare.

“In fact, it only happened nine days during that long stretch of time,” he said.

The statistics were very similar for the Dow Jones industrial average and the Russell 2000 index, he noted.

The worst-of structure may increase the chances of losses by a certain amount, which he was not able to calculate lacking the data and model to generate such simulations.

“But obviously the risk remains negligeable,” he said.

Better safe than sorry

While the barrier was unlikely to be knocked out, having such a margin of safety was very valuable for some clients.

“The barrier is very good. It gives you a rock-solid protection, which is why you buy structured notes in the first place. It also fits the profile of the buyer of this type of note, someone probably pessimistic about equity markets,” he said.

He would not change the barrier level.

“Some may think that the cost of putting this barrier is too high and that the money would be better spent on the upside by introducing some leverage or increasing the digital,” he said.

“But that’s not what the note is designed for. This is a bearish note.”

Absolute return

The absolute return allows the notes to outperform if the index drops between 0% and minus 35%.

But the non-payment of dividends will narrow the margin by 10%, which is this adviser’s hypothetical cost of not earning dividends over five years based on a 2% dividend yield.

The S&P 500 index has declined by 10% to 35% over a five-year period only 8% of the time, according to this adviser’s back-testing data.

“The absolute return gives you a chance to outperform only 8% of the time,” he said.

“You’re not very likely to benefit from it. But for some clients, this absolute return is very attractive.

Digital, no cap

On the upside, the odds of making money are much better, he said.

Statistically, the S&P 500 index has an 83% chance of finishing up over a five-year period.

“We all know that: on average, the market is up more often than it is down,” he said.

Factoring in the 10% of unpaid dividends, investors will outperform if the positive price return of the S&P 500 is below 33%.

“That’s a pretty large bucket. You can massively outperform if the index falls into that range,” he said.

“It’s also uncapped, which is also very attractive even without dividends.”

For instance, if the final total return of the S&P 500 index is 60%, noteholders would get the 50% price return.

“It’s less. But I don’t think a lot of people are going to be upset about that,” he said.

Custom-made

To conclude, he said that the notes may be a great fit for the more “negative” or “pessimistic” investor.

“It is designed for bears. They get an almost bond-like protection on the downside with absolute return. But “If they’re wrong, if the market is up, they will either outperform with the digital or get the uncapped price return. All your bases are covered,” he said.

“I don’t personally like the notes because I’m optimistic for the five-year period. But for a bear, it is the right design. I don’t know how much of a better job the issuer could have done.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on May 25.

The Cusip number is 48133WQR2.

The fee is 2.5%.

© 2015 Prospect News.
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