JPMorgan shows its own ‘condor-like’ trade with dual directional knock-out notes tied to S&P

By Emma Trincal

New York, June 27 – In a market that lacks direction, investors are increasingly paying attention to range bound or dual directional trades. All the better if they can get both with the bonus of full principal protection. That is the purpose of a relatively new structure, which some market participants have likened to an options strategy called “condor” with some distinctions. The nameless structure has been alternatively dubbed “weird condor” or “condor-like.”

Main concept

At the core of the structure is a pair of barriers – upper and lower. Money is made in between those strikes.

When the underlying price finishes between the two barriers, investors get to participate in the absolute return of the index price move up or down. The barriers cap the return both ways.

When the price finishes outside of the range, investors benefit from two features: full principal protection is one. The second is an extra payout offered as a bonus. The size of the payout is a function of the width of the range and investors’ views on the market.

Coming up deal

The last example of such trade is JPMorgan Chase Financial Co. LLC’s planned dual directional knock-out notes due July 2, 2020 linked to the S&P 500 index.

If the index ends above its upper knock-out level, the payout at maturity will be par. The upper knock-out level will be 110% of the initial index level, according to a 424B2 filing with the Securities and Exchange Commission.

If the index ends at or below its upper knock-out level and at or above its lower knock-out level, then the payout at maturity will be par plus the absolute value of the index return. The lower knock-out level will be 80% of the initial index level.

If the index ends below its lower knock-out level, the payout at maturity will be par plus 6%.

Bearish bias

“It’s a bearish deal because you’re really giving up the upside by getting only par when you get above 10%,” a market participant said.

“But it’s an interesting story, especially in this market. If it’s flat or up a little bit, that’s good.

“Investors are protecting themselves not against a bear market sell-off but from prices lower from where we are now.”

Nowhere trade

This market participant said the full principal protection over only two years was attractive. The structure indeed allows for 100% protection on very short tenors. Two previous deals brought to market last month had maturities of two years and less.

“I like it. It’s for an adviser who thinks we’re at the top of the range. It can offset the risk on the portfolio,” the market participant said.

“If the market falls into bear market territory down 20% or more, at least he gets 6%. That’s 3% a year.

“It’s a ‘nowhere’ trade with a slight bearish tilt.”

Real condors

So why the term condor for a product, which combines full principal protection, delta one participation, absolute return and a digital payout?

A structurer offered an explanation, beginning to explain what a typical condor trade is and is not. Using the same barriers or strikes than those in the deal, a “true” condor would be as follows:

“You’re long 100 strike call and short 110 strike call,” he said. This means investors’ return is one-to-one from 100 to 110. After 110, the profit is capped at 10%.

That would be the first spread.

The condor also includes a put spread.

Using the same barriers, the put spread would be: long 100 strike put and short 80 strike put, he added.

As a result of this position, investors gain the absolute return of the price decline from 100 to 80 on a one-to-one basis. When the price falls beyond 20%, their profit is capped at 20%.

A different bird

“You can see that the notes are not exactly that. The notes are not a pure condor,” he said.

“It’s not a condor upward because after 110, you don’t get to keep your 10%. You lose it. You only get par.

“And it’s not a condor downwards because if the price falls below the 80 strike, you don’t get to keep your 20%. You lose it or at least a big chunk of it. You lose 14 of it since they give you 6.”

Knock-out

The structure shifts from a pure condor strategy. It eliminates or reduces the maximum returns normally achieved at the barrier levels, he explained.

On both sides of the trade, the issuer creates a knock-out by shorting a digital option at the upper and lower strikes.

“On top of the condor: you just add another condition. You sell a 10 digital with a barrier at 110. That’s the knock-out. The note will have to lose 10% if it goes to 110. That’s how you wind up getting only par,” he said.

On the downside, the same principle applies.

“We’re already long a 100 put and short an 80 put. That’s the left wing of the condor. But we know that with this particular trade, the terms are different. When I hit the 80 strike I get 6%, not 20%.

“You do that by selling a 14% digital at a European barrier of 80.

“When you hit 80, you get to keep only 6% out of the 20% because you have shorted a 14% digital at that strike.

“These notes are nothing but a condor with two digital options. It’s a condor with a short digital position on the right and a short digital position on the left,” he said.

Timely

The structurer predicted that such trades may gain in popularity in today’s market environment characterized by lower return expectations and a growing need for protection. The ability to strike those deals short term is also a benefit.

“They do those deals for a reason. It’s for investors who view the market as trading sideways. You’re maximizing the middle,” he said.

“The structure is like a penalty kick. Your goal posts are 80 and 110. All you’re trying to do is kick the ball between those two posts.”

Not the first one

Last month, UBS priced two “condor-like” deals on behalf of Credit Suisse AG.

The first one for $2.53 million was an 18-month trade on the S&P 500 index. The upper and lower ranges were 17%. The payout outside of the range was 1.5% on each side.

The second one priced at $19.53 million. It was a two-year. The lower and upper barriers were situated 20% below and over the initial price. The payout if the index finished outside of the range was 2%.

Flexible solutions

All the different versions of the same concept are a reflection of investors’ view on the market., the structurer said.

“This one is skewed toward the downside. It’s slightly more bearish. Your range of profit on the downside is twice more than on the upside. Also, you get paid if you breach the lower barrier, which is not the case with the upper barrier.”

The structure can be used in many different ways depending on the investor’s market outlook.

“You could have put your two goal posts at 85 and 115 if your view was more neutral. Or 90 and 120, if more bullish. It depends on what you think the best probabilities are to kick the ball between the two goal posts,” he said.

The notes will be guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will price on Thursday and settle on July 3.

The Cusip is 48129M4U7.

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