JPMorgan’s bearish barrier notes on S&P 500 offer tactical hedge with early redemption feature

By Emma Trincal

New York, Jan. 13 – JPMorgan Chase Financial Co. LLC’s 0% bearish barrier early redeemable market-linked notes with daily barrier observation linked to the S&P 500 index give investors a chance to monetize a pullback, hedge a portfolio and pay a limited price if they’re wrong, sources said.

The maturity date will be between Nov. 30, 2021 to Feb. 28, 2022, according to a 424B2 filing with the Securities and Exchange Commission.

A barrier event will occur if the index’s closing level is less than 75% of the initial index level on any trading day during the life of the notes.

If a barrier event occurs, the notes will be redeemed and holders will receive par.

If a barrier event has not occurred and the index finishes at or above its initial level, the payout at maturity will be par.

If a barrier event has not occurred and the index finishes below its initial level, the payout will be par plus the absolute value of the return of the index.

Protection, liquidity

“There are a few aspects of this note I like,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“First, if your view is bearish and if you’re right, it allows yout to make money without losing money on the upside. You get your principal back no matter what,” he said.

“It’s also nice if the market is down more than 25% to get some cash back right away, which you can redeploy.

“If the S&P is down 30% you lose the opportunity to make money from the notes but you can buy the market at a much lower price.

“It offers a number of opportunities.”

Different animal

Issuers occasionally show bear notes. Some called “shark notes” will offer full principal protection, such as this one.

Others won’t.

Autocallable bear notes, which provide potential early redemption like this one, have been seen but are still fairly uncommon. For the most part, investors have to hold their bear notes until maturity.

The early redemption feature in this structure, allowing investors to reinvest their liquid asset at lower prices, is what makes the product unique, Chisholm said. The feature is distinct from an automatic call, which would pay a premium or coupon upon the early redemption. It’s also slightly different in that there are no determination dates. The early redemption can be triggered at any time, which is determined by the breach of the 75% “American” barrier.

“The early redemption is what makes this note really appealing. Without it, it wouldn’t be so interesting,” he said.

Cautiously optimistic

Carl Kunhardt, wealth adviser at Quest Capital Management, said the notes were different from other bearish products. For one thing, they provided investors with a relatively cost-efficient hedge.

“I typically don’t like these kinds of bearish notes. You don’t see them very often and when you see them, they have terms that are really unattractive,” Kunhardt said.

“You really have to have a bearish view for them to make any sense at all.”

This adviser said he is not bearish on the market for the next two years or so.

“We have a cautious outlook. Interestingly JPMorgan are among the analysts we follow and they don’t see any correction until at least 2021,” he said.

“I wouldn’t make a positive or negative call for 2021 at the beginning of 2020. And given that our outlook is cautiously optimistic, this note would not make sense for us as a bearish bet.”

However as a hedge, the note deserved consideration, he said.

“I would only use it for one reason: protecting the portfolio on the downside. If the S&P is down by 25% or less, this note will outperform the market. If it’s not, I’m not losing any money. But I’m incurring an opportunity cost.”

If on the other hand, the market continues to be bullish and is up 30%, investors would “significantly underperform,” he added.

“You could have a significant opportunity cost depending on what the market does. If, as we expect, the market is up 8% a year, there would be some money left on the table. But it would be nothing like last year when the market was up 29%,” he said.

Relative value

Since investors never know whether their outlook will be correct or not, hedging is a necessary part of investing, he said. But it comes with a cost.

“There is no free lunch,” he said.

“The main issue for investors considering the notes is to evaluate how they fare in terms of cost compared to other hedges such as investing in a hedge fund or buying a put option, he said.

“You first have the cost of the note,” he said, pointing to the 1.5% fee disclosed in the prospectus.

“It’s not overly expensive,” he said, especially when compared to the management and performance fees of hedge funds or the premium one has to pay to buy a put option.

Additionally, the position in the note will not be adversely affected by a rising market.

“If you hold alternative investments or a put position, the impact of a rally is going to drag your overall performance, which is not the case here. The worst that could happen is that you’ll get your money back.

“That’s why the real cost of this note is the opportunity cost. And that’s all there is,” he said.

Is it a high price to pay for a hedge? It will depend on investors’ market outlook, he said.

“You run the risk of missing out on a rally, so it wouldn’t be suitable if you’re very bullish.

“But if all you need is a hedge – and we’re always going to have a hedge – in this case it is very cost-effective. So surprisingly, even though I don’t usually care for bear notes I do like this one.”

The notes will be guaranteed by JPMorgan Chase & Co.

UBS Financial Services Inc. and J.P. Morgan Securities LLC are the agents.

The notes will price on Jan. 28.

The Cusip number is 48132HSE3.

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