JPMorgan's worse of autocallables tied to indexes, ETF offer 7.15% yield in hybrid structure

By Emma Trincal

New York, Oct. 22 - JPMorgan Chase & Co.'s autocallable yield notes due Sept. 5, 2013 linked to the lesser performing of three reference assets combine worse of, reverse convertible and autocallable features to give investors a complex structure but one that pays an above-average yield, sources said.

The "worse of" part corresponds to the inclusion of a multi-asset underlying, which is not a basket.

The notes are tied to two indexes - the Russell 2000 index and the S&P 500 index and one fund - the Market Vectors Gold Miners exchange-traded fund. The payment at maturity or the call will be linked to the performance of each underlier, not the performance of a basket, according to an FWP filing with the Securities and Exchange Commission.

The reverse convertible part is reflected in the payment of a 7.15% per year coupon paid regardless of the underlying performance.

Finally, the autocall kicks in automatically if each underlying closes at or above its initial level on May 1, 2013, May 31, 2013, July 1, 2013 or July 31, 2013.In such case, the notes will be called at par.

The payout at maturity depends on the incidence of a trigger event, which occurs when the closing level of any underlying component is less than its initial level by more than 40% on any day during the life of the notes.

The payout at maturity will be par unless any underlying finishes below its initial level and a trigger event has occurred, in which case investors will lose 1% for every 1% that the worse-performing component declines below its initial level.

"It doesn't look like much of a new product," a sellsider said, although the combination of the call, the deep barrier and the multi-asset underlying make the structure relatively sporadic.

"It's a decent deal. The S&P 500, the Russell are well known. The Gold Miners is probably the most volatile. If one goes down a lot it's probably going to be the gold miners. The maturity is fairly short-term," he said.

The notes are not callable for the first six months, which can be an advantage for investors who shy away from reinvestment risk, sources said. While investors in autocallable notes often seek an early exit scenario, the call may make it more challenging to reinvesting the proceeds at a comparable yield.

The most eye-catching aspect of the deal was the high-paying coupon, the sellsider said.

"The coupon given this low interest rate environment is fairly attractive," he said.

Investors receive the high coupon but take more risk for that, just as with a reverse convertible. The main one is the occurrence of the trigger event, which cancels the downside protection, he said.

"The barrier of 40% is significant. The risk is in the fact that the knockout can happen any day," he said.

Another risk factor associated with worse of deals is when there is no or little correlation between the underlying assets.

In such case, the chances of any of the three to go down are greater than when they all move in the same direction, he explained.

"Intuitively, gold is not really correlated with the two equity indexes, so that's adding some risk to the product," he said.

The short duration, this sellsider said, has both positive and negative implications.

"The good part of having a 10-month term is that it takes a while before you hit the 40% trigger, so it may just never happen," he said.

"But if it happens, let's say during the seventh month, it will probably be difficult to recover from the loss because the barrier is pretty far. The knock out is unlikely to happen, but if it does happen, you're probably going to experience a loss of principal," he said.

But how probable is it for the 40% barrier to be breached? Scott Cramer, president of Cramer & Rauchegger, Inc., said that apart from a tail risk event, the odds were relatively slim.

"It doesn't sound bad to me at all especially given the yields that are available at the moment," he said.

"The only thing that would drive something like a 40% decline would be an outside event: some horrific news or a terrorist attack.

"Even the gold miners, the most volatile of the three, is unlikely to drop by that much in such a short period of time," he said.

The Market Vectors Gold Miners ETF fell 28% from its high this year in February to its low in May.

"My point is that 40% is a lot," he said.

"This is a good trade for somebody willing to take a chance that a big outside event is not going to happen in the next 10 months.

"Now if Iran and Israel attack each other, all bets are off," he said.

Cramer said that the conditions for a call were difficult to achieve as all three underliers had to be above their initial price on a given quarterly date.

"But I don't care if it gets called. It's a non-event to me," he said.

"What I do like is the 7.15% coupon and the deep barrier.

"I think it gives this product a fairly attractive risk-reward," he said.

The notes (Cusip: 48126DED7) are expected to price Oct. 31 and settle Nov. 5.

J.P. Morgan Securities LLC will be the agent.

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