JPMorgan’s autocall buffered return enhanced notes on S&P combine call and leverage

By Emma Trincal

New York, July 15 – When volatility is low and premium limited, firms must be creative to offer shorter terms, hard buffers and uncapped leveraged exposure, features often high on the wish list of advisers.

JPMorgan has sold a few offerings whose structure fit the description.

Its upcoming one – JPMorgan Chase Financial Co. LLC’s 0% autocallable buffered return enhanced notes due Feb. 2, 2022 linked to the S&P 500 index – is set to price at the end of the month.

The notes will be called at par plus 6% if the index closes at or above its initial level on June 28, 2021, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 2 times any index gain.

Investors will receive par if the index falls by up to 10% and will lose 1% for every 1% decline beyond 10%.

Intriguing structure

“It’s a clever, innovative structure,” said a market participant.

But something in the pricing had to allow the bank to offer double leverage on the upside with no cap and a 10% hard buffer on an 18-month tenor, he added.

“The trick is that you’re starting below initial level. If in one year you’re not called, it means you are negative. You are below the initial level. And now you only have six months to rise above par.

“If your return is negative or slightly up, the leverage can’t do much for you.

“Six months is a fairly short time to rebound.”

The key consideration is to evaluate the probabilities of a call in one year.

“It’s an interesting note. But I would have to do some back testing to see what the odds are.

“My guess is that you’re more likely to get called than to get your payout at maturity.

“It’s intriguing. But I would have to take a closer look to see if it makes sense.”

Other versions

This is not the first time an autocall is integrated in a leveraged product.

Morgan Stanley for instance has priced 0% buffered jump securities, which may be called automatically on an annual call date with a call level at par. If called the notes will pay a call premium. If not, the index gain will be enhanced with leverage, and just as this one, no cap. Buffers are also part of the package.

The most recent was Morgan Stanley Finance LLC’s $484,000 of 0% buffered jump securities with autocallable feature due June 30, 2022 linked to the worse performing of the S&P 500 index and the Russell 2000 index. The deal, which priced on June 25, offered slightly better terms (8.5% premium for the one-time call, 15% buffer) which is not surprising for a worst-of with a slightly longer tenor. The 1.25x leverage was lower.

Morgan Stanley priced two similar deals at the end of May for $1 million and $307,000, respectively.

JPMorgan’s “autocallable buffered return enhanced note” as a “brand” has a longer history dating back to 2011. But the firm has done more deals recently, selling as many this year as it did from 2011 to 2014, according to data compiled by Prospect News.

Digital autocall

When it comes to mixing a return enhancement feature with an autocall, the most common route so far has been the use of a digital payout, not leverage.

Examples include “buffered booster notes,” distributed by RBC Capital Markets or autocallable market-linked step-up notes, a best-selling product, which BofA Securities sold billions of across its distribution channel.

Those deals do not provide leverage at maturity but a potential digital return, which is often the sum of the call premium, which the snowball would have paid each year. There is typically uncapped participation above the digital level, but on a one-to-one basis.

Secret sauce

Again, the “trick” of those structures is that by the time the notes mature, the underlying is probably negative as the call has failed multiple times. Investors may get the digital return but any return above it is less likely to happen since there is not enough time for the underlying to jump from below par to the sum of all annual call premiums between the last call date and the maturity date.

The JPMorgan structure is “innovative” in that it introduces the leverage at maturity rather than the most common digital form of return enhancement. But the principal remains the same.

“Pricing is cheap because it’s an improvisation on a snowball. You’re not really purchasing an 18-month uncapped buffered leveraged note,” the market participant said.

“What’s going to happen is you’ll be called. The probability of getting the leveraged payout is limited.”

Snowballs are autocallable notes which generate a call premium upon the call, unlike coupons which get paid on a contingency or guaranteed basis throughout the life of the notes. Snowballs have a “memory,” which means that investors, when the notes are called, will “catch up” the cumulated amount of call premiums missed in the previous observation dates.

J.P. Morgan Securities LLC is the agent.

The notes will be guaranteed by JPMorgan Chase & Co.

The notes will price on July 28 and settle on July 31.

The Cusip number is 48132MTW1.

The Cusip number for the Morgan Stanley notes is 61771BKG8.

© 2015 Prospect News.
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