JPMorgan’s uncapped digitals on S&P, Nasdaq aimed at navigating a post-bear market environment

By Emma Trincal

New York, Sept. 23 – JPMorgan Chase Financial Co. LLC’s $801,000 of 0% uncapped digital barrier notes due Sept. 23, 2027 linked to the lesser performing of the S&P 500 index and the Nasdaq-100 index offer a minimum guaranteed return, no cap on the upside and some protection on the downside, features that may appeal to a wide range of investors at the exception of bulls on the lookout for a post-bear market rebound.

If the worst-performing index finishes at or above its initial level, the payout at maturity will be par plus the greater of the worst-performing index’s return and 57.45%, according to a 424B2 filing with the Securities and Exchange Commission.

If the worst-performing index finishes below its initial index level but greater than or equal to its barrier level, 70% of its initial index level, the payout will be par.

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

Bear market

“That minimum return is 10% a year. But you lock out your money for five,” said Steve Doucette, financial adviser at Proctor Financial.

For Doucette, the market in five years is likely to be much higher than today.

“This is a good note if both indices are only up a little, meaning if they’re up less than 10% a year. But is it going to be the case five years from now after a bear market?” he said.

The average bear market lasts 18 months, he noted.

“Right now, we already are in that negative cycle, and we’ve been in it for a little bit less than a year.”

Based on Friday’s close, the S&P 500 index was down 23.4% from its Jan. 4 peak. The Nasdaq lost 33% from its Nov. 22 high.

Focus on 57%

“We’re already down a lot. Five years out, chances are we’ll already be in a bull market although you never know,” he said.

If the market ends up higher, the value of the notes will depend on whether both indices finish above or below the 57% digital threshold, he said.

“If the market is up by less than 10% a year, the notes will outperform thanks to the booster; if not, there’s no benefit in owning the notes,” he said.

Indeed, if both indexes finish above the 57% level, the digital payout no longer applies and investors are just “long” the lesser performing index, he said.

“Suppose the Nasdaq is up 80% and the S&P is up 40%...You’re stuck with a 40% return over five years,” he said.

Dispersion risk

The worst-of and the long duration were the main drawbacks, he said.

“I know those two indices are correlated, but still. You only get the worst return. If you’re bullish, you’re better off buying both indices,” he said.

In doing so, gains from one position could offset some or all of the losses from the other, he explained.

“The only way you’ll outperform the market regardless of the fact that it’s a worst-of, is if they’re both up by less than 57%. But how likely is it to happen five years from now?” he said.

Raising the ‘coupon’

A more positive characteristic of the structure was the downside protection.

“With the 70% barrier, you’re much more likely to outperform. I have a hard time thinking we’ll be down more than 30% in five years,” he said.

Even less protection would be acceptable over the five-year timeframe.

“That’s how I may negotiate a higher digital. I’d be willing to give up some of the barrier maybe give up 10% of it if I could raise the digital above 57%,” he said.

“A buffer would be even better because you’re guaranteed to outperform all the way down. So, I wouldn’t mind replacing the 30% barrier by a 10% buffer. But buffers are expensive. I don’t know what it would do to the coupon.”

Covering both sides

Jeff Pietsch, founder of Capital Advisors 360, said that having an uncapped and guaranteed minimum return along with some protection on the downside was attractive in many ways.

“You are betting that the market will be between 0% and 57% in five years. It’s not a bad bet,” he said.

“You’re still exposed to the downside, but with a 30% barrier the probabilities of losing money are very small.

“Look at current levels: between the two indices the market is already down 20% to 30%. Getting an additional 30% drop in five years seems unlikely. So that looks like a very reasonable protection to me.”

Minimum payout

For Pietsch, the protection did not take away any of the benefits on the upside.

“You’re guaranteed a 9.5% annual return on a compounded basis. If you exclude the dividends, that’s a 7.5% annual return,” he said assuming a 2% opportunity cost due to the non-payment of dividends.

“That 7.5% is still very close to the long-term historical return of the S&P. I think it looks pretty attractive. You’re guaranteed a very reasonable rate of return while still having downside protection,” he said.

Uncapped

Another positive was the fact that the digital payout was uncapped.

“If we have a blow-up recovery, you can still participate. There is no penalty,” he said.

Based on the cyclically adjusted price-to-earnings (CAPE) ratio, he said he expects lower single digit returns for the S&P 500 index over the next few years.

“Why wouldn’t you look at guaranteed high single digit returns with that barrier protection? I don’t see what’s not to like about this deal unless you’re extremely bullish. And if you are, you should probably buy the ETFs.

“This note is not perfect. It’s a five-year holding period. Your return is tied to the worst-performing index. But that’s how the issuer was able to price it.

“In my view, the tradeoff is very attractive,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on Thursday.

The Cusip number is 48133MZW3.

The fee is 1.125%.

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