JPMorgan's 9% autocallables linked to indexes, Amazon offer new twist on worst-of structure

By Emma Trincal

New York, June 5 - JPMorgan Chase & Co.'s $3 million of 9.1% autocallable yield notes due Dec. 3, 2014 linked to the S&P 500 index, the Russell 2000 index and Amazon.com, Inc. shares introduced the use of a stock as an underlying component along with two indexes in a worst-of deal, a structural feature sources said was innovative yet risky.

Adding a stock, especially Amazon, which is characterized by high volatility, was a way for the issuer to provide investors with a higher yield, they noted.

Interest is payable quarterly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus accrued interest if all of the components close at or above their initial levels on any quarterly call date.

A trigger event will occur if any component falls below the 65% trigger level on any trading day during the life of the notes.

The payout at maturity will be par unless a trigger event occurs and the return of the worst-performing component is negative, in which case investors will share in the losses of the worst-performing component.

Injecting volatility

"It's very risky. It's also interesting. When you're mixing the S&P and the Russell with a stock like this one, it almost seems like you're trying to camouflage that the risky Amazon stock is in there," a market participant said.

The notes were designed for yield-seekers since the 9.1% income is paid regardless of the stock performance.

However, the prospectus warned that if the notes are not called, investors may lose their entire initial investment. Another risk factor, according to the prospectus, is the potential lack of correlation between the three underlying components. It could be a risk as those do not represent a basket but instead three individual underlyings.

"Obviously, they put Amazon there to get more volatility and therefore more coupon," the market participant said.

The implied volatility for Amazon is 26% versus 16% for the S&P 500.

"It's a little play on a reverse convertible theme where either you get the worst of the three or your principal back with the accrued coupon at some point in time," he said.

"I've seen worse structures than this one, not just among worst of. It is what it is. If somebody was going to invest in Amazon anyway, maybe that would be a way to get the 9% yield."

Amazon play

A structurer said that should a trigger event occur, its cause would be more likely to be the performance of Amazon rather than that of either of the two indexes.

"You have the S&P, the Russell. You might as well just cross these out. It's a straight play on Amazon, which is where the volatility is," this structurer said.

"You get a potential 9.1% yield on Amazon. It's pretty much the same as a straight autocallable on the stock.

"They're throwing two indexes in there plus a stock. But the different pieces are not very correlated. Even though both indexes have gone up, they represent two different sides of the market. Amazon is also not correlated. And Amazon is a curveball - that's the piece that's out of the norm."

This structurer said that when issuers want to add more volatility to a worst-of product, they tend to "throw in" commodities, currencies or sector plays, sometimes baskets of ETFs in addition to the typical equity indexes.

"But a single stock ... That's interesting, even a bit gimmicky," he said.

"We all know what's going to happen. If the Russell and the S&P are down, Amazon is probably going to be worse. The whole question centers on the 9% annual return. Is this enough to get you to make that kind of decision? Is this return worth the risk? Is the 65% bar okay? That could be right. A 65% drop is a lot. We're talking a year-and-a-half, not a two- or three-year."

Stock, structure add risk

"But still. It's a stock, and Amazon is pretty volatile. On an individual stock, it may take only a week to drop 35%," the structurer said.

The share price of Amazon back in October was $260. In mid-November, the stock dropped to $220.

"That's a pretty significant drop in a really short time. Not the end of the world though since in January it went back up to $285. But with those peaks and valleys, you're obviously incurring a greater amount of risk.

"At the end of the day an investor may look at it and say, 'Okay, it's a one-and-a-half-year, but it's callable after three months. What's my probability of getting called?' They may think it's worth the shot and may want to take advantage of the structure to get that 9% coupon.

"The reality is people do this because they're desperate for income. For them, it's worth the risk.

"We've been trying to stay away from these transactions designed to bump up the coupon to a point where the offer is hard to resist and the client [is] almost forced to trade that out."

This structurer said that his firm was prepping a structure that was similar but designed to lower the risk.

"We've been thinking of showing a similar kind of transaction, but instead of one or two indexes plus a stock, we're looking at four or five stocks. That in itself is not the new part. What we're bringing into the equation is an additional cushion. What we're saying is even if the barrier is triggered, as long as one of the four stocks is up 10% from its initial value, you get principal protection. It's an added protection.

"The idea behind this is that we like the structure but we want to reduce the potential pain induced by the trigger. Who knows where the Russell, the S&P and Amazon are going to be a year and a half from now?

"Nobody in the business is a magician. So we've added that caveat. It reduces your coupon a little bit, but it also reduces the impact of a knock-out. The knock-out can be so devastating in some portfolios, we've tried to rearrange the structure in order to bring more protection on the downside," he said.

J.P. Morgan Securities LLC was the agent.

The notes (Cusip: 48126NCX3) priced May 30.

The fee was 1%.

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