JPMorgan’s uncapped dual directional leveraged notes on indexes best used as hedge, bear play

By Emma Trincal

New York, July 3 – Despite upside and uncapped leveraged exposure, the structure of a recently priced note by JPMorgan favored investors seeking to outperform in a down market, advisers said.

JPMorgan Chase Financial Co. LLC plans to issue 0% uncapped dual directional accelerated barrier notes due July 3, 2025 linked to the least performing of the Dow Jones industrial average, Russell 2000 index and S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

If the worst-performing index gains, the payout at maturity will be par plus at least 1.11 times the return of the worst-performing index. The exact leverage factor was to be determined on the trade date.

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 the 70% barrier.

Investors will lose 1% for every 1% that the worst-performing index declines if it ends below the barrier.

Tradeoff

“I like the no-cap. Clients are always worried about underperforming the index. And the 30% barrier is very healthy,” said Tom Balcom, founder of 1650 Wealth Management.

Balcom said he was also “comfortable” with the short timeframe.

“Pre-Election periods tend to be volatile. Two years from now, the elections will be behind us. We will have a new president in office,” he said.

One disappointing aspect of the structure was the leverage factor.

“1.1 times isn’t much. But you’re getting a 30% barrier over two years. That’s the tradeoff. If you want more upside, you’ll get less protection. If you want more protection, you’ll have to give up some of the upside. That’s just how it works.”

At least the 1.1 leverage factor was probably sufficient to compensate investors for losing the dividend payout, he noted.

“The upside is a little bit like being long the market. You don’t lose the dividends; and you don’t have a cap.”

Hedge

The main value of the note came from the barrier and absolute return, he said.

“You get the protection, and you get a hedge. I wouldn’t say the note is bearish. But it’s a defensive way to get your equity exposure,” he said.

“Bulls may like it because of the no-cap. The more cautious type of investors would probably like it even more. Wealth preservation is key for most clients. This note is a way of doing that.”

Opportunity cost

Another financial adviser agreed that the notes offered some appeal but not for bulls.

“At first, it does look bullish. You have no cap and a little bit of leverage. It’s very rare to be uncapped over such a short period of time. Usually, you have to go out four or even five years. So that’s a positive,” he said.

To fully analyze the risk reward profile of the notes, this adviser used for each index back-testing data over two-year rolling periods.

Based on his figures going back several decades, he found that the market ended up positive 82.6% of the time with the S&P500 index, 86.3% of the time with the Dow and 81.5% of the time with the Russell 2000.

“Basically, more than 80% of the time, it’s going to be up after two years,” he said.

Since the main benefit of the notes was delivered during market declines, he wondered how bullish investors could really take advantage of the notes.

“The 1.1 times is only going to help you offset some of the loss in dividend. But it’s not going to enhance your return at all. And with more than 80% chances to see the market finishing up higher, there is a high probability that the note may not do much for you,” he said.

Risk

Assessing the downside risk, this adviser looked at the frequency of price drops in excess of 30% for each index and over two-year rolling periods.

He found that the odds of such “barrier breach” scenario were relatively low – 3.1% for the S&P 500; 2.5% for the Russell 2000; and 2.5% and for the Dow.

“The chances of losing money are not huge. This 70% barrier is not bad,” he said.

Absolute return

The best outcome on the downside was a decline above the 70% barrier level.

“That’s the absolute return band, by far the best outcome if you want to outperform the market,” he said.

“It’s in that range that you get the best value.”

While appealing, the absolute return scenario only occurred 16% of the time, he said.

“I wouldn’t hang my hat on it. But that’s what gets people excited about this note. To me though, I think the chances of that happening are just too slim,” he said.

Worst-of

In his statistical analysis, this adviser admitted that he did not consider the impact of the worst-of payout lacking the tools to do so.

On the negative side, the exposure to the worst-performing index increased the probabilities of breaching the barrier, he said.

On the positive side, if the price declined within the absolute return area, the worst-of exposure would provide the equivalent of a “best-of” return.

“The bull in me would not find much value in this note. Obviously, it’s mostly a bearish note,” he said.

“There is an 80% chance that the market is going to be up in two years. I’d rather have more leverage than the absolute return. Even if it was 1.2x or 1.3x I would be quite happy with that.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes were expected to price on June 30 and to settle on July 6.

The Cusip number is 48133XZF6.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.