JPMorgan’s $600,000 uncapped leveraged notes on indexes offer longer-dated bullish bet

By Emma Trincal

New York, Oct. 20 – JPMorgan Chase Financial Co. LLC priced $600,000 of 0% uncapped contingent buffered return enhanced notes due Oct. 21, 2024 linked to the least performing of the Russell 2000 index and the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

If each index finishes above its initial level, the payout at maturity will be par plus 1.313 times the gain of the least performing index.

Investors will receive par if the least performing index falls by up to 30%.

Otherwise, investors will lose 1% for each 1% decline of the worst performing index.

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he was comfortable with the trade-offs associated with the advantageous aspects of the deal.

Surprisingly small

“It’s hard to quibble about this note, and frankly I’m surprised they did only $600,000 of it. It’s probably a one-off,” he said.

“I love the uncapped with 1.3x. That’s just great.

“JPMorgan is a solid name. We have no problem with them.

“The 70% barrier is good, especially on a four-year.”

In addition, the leverage was “good enough” to offset the negative impact on the return of the non-payment of dividends over the period, he noted.

Long tenor, worst-of

Long durations can be a significant drawback for investors. But not for this adviser.

“It’s a four-year, but for us, longer maturities are great. We typically like five, six or even longer terms,” he said.

“So, the fact that this note is a four-year is actually a plus for us. We want our investors to be long-term holders.”

The exposure to the worst of two indexes rather than to a single index is also not always welcomed by investors as it adds risk.

But here again, Kalscheur did not object.

“In our experience, the worst-of is what gets you those terms. A worst-of will significantly improve pricing,” he said.

“For that reason, we are comfortable with that kind of payout.”

High correlation

Kalscheur said he is even more comfortable given the correlation between the two underlying indexes.

“Worst-of can be a problem when you get pretty big divergences in performance between the underlying assets. But these two, while not exactly in lock step, are certainly highly correlated,” he said.

The coefficient of correlation between the large-cap and small-cap benchmarks is 0.917.

“I’d much rather have 1.3x leverage on the Russell and the S&P than 1.05x on just the S&P,” he said.

Other times, investors obtain uncapped leveraged return on a single index at the price of a significant extension of the maturity.

Recently some uncapped leveraged notes tied to the S&P 500 index have been seen showing 1.5x leverage or less, barriers in the 65%-60% range but with considerably extended maturities, up to 10 years.

Four-year rolling period

Kalscheur said the downside risk associated with the notes was reasonable in large part due to the long tenor.

He runs analytics using performance data for the S&P 500 index and for the Russell 2000 index going back to 1950 and 1987, respectively.

The chances of breaching the barrier on any four-year rolling period was less than 1% for the S&P 500 index and 0.5% for the Russell 2000 index, his data showed.

“Most people would be happy with having less than 1% chance of breaching the barrier,” he said.

The probabilities of the indexes being negative at maturity but above the 70% threshold were 16.7% for the S&P 500 index and 13.5% for the Russell 2000.

“These are the situations showing when the barrier will help you,” he said.

The worst-of introduced more uncertainty since the frequencies extracted from the back-testing are for one index at a time, he noted.

“But I think the risk over a four-year period as opposed to one year or two year is pretty small,” he concluded.

Credit, fee, underlying

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, agreed about the limited risk. As a result, the structure was too defensive and out of balance, he said, even as he pointed to some positive aspects of the deal.

“JPMorgan is a very strong credit...the strongest of American banks. And we also like the fee,” he said.

The fee is 0.85%, according to the prospectus.

“Another positive thing is the correlation. Anytime you have a worst-of, it’s always nice to have assets that are highly correlated like the S&P and the Russell. There is a good chance that they will show a reasonably similar performance even though you have some divergences, as large-caps have outperformed small-caps,” he added.

Too long

But Foldes pointed to features he did not find attractive as well.

“First, four years is too long. We typically stay away from a note longer than two or three years,” he said.

The long maturity made the downside protection unnecessary in his view.

“Having a 70% barrier on a four year is not the best use of your cash. We do like the uncapped upside but are disappointed by the 1.3 times leverage. We’d rather see no barrier on the downside and more leverage on the upside,” he said.

The leverage factor was required not just to enhance the return but to offset the negative impact of not getting paid the dividends.

“You give up that dividend yield in the neighborhood of 1.5%-1.7% for four years and you only have 1.3 times leverage to make up for it,” he said.

Better trade-off

Foldes said the chances of losing money over a long period are limited.

“Over that long-time horizon, I’d much rather be long the index fund and enjoy the benefits of the dividends. The leverage is surprisingly low when you think you’re paying for that by virtue of giving up the dividend over a relatively long period of time.”

Overall, Foldes said he would rather see more leverage and possibly a shorter maturity even if he has to give up the downside protection, which he would do easily over a long tenor.

“I’d look at a barrier if I was doing 12 or 24 months. But if I’m going to go out four years, then I’d rather get the maximum leverage possible. I don’t need the barrier when the chances of losses are greatly reduced.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes priced on Friday and will settle on Wednesday.

The Cusip number is 48132PNK6.

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