Energy boosts yield in JPMorgan’s $6.45 million autocall on S&P 500 ETF, Energy Select Sector

By Emma Trincal

New York, April 21 – JPMorgan Chase Financial Co. LLC’s $6.45 million of trigger autocallable contingent yield notes due April 22, 2027 linked to the lesser performing of the SPDR S&P 500 ETF Trust and the Energy Select Sector SPDR Fund provide a double-digit coupon with a defensive barrier at maturity, sources said, two attractive features. But those terms were achieved via the use of a relatively volatile energy fund, making the investment decision mainly a function of investors’ view on the sector.

The notes will pay a contingent quarterly coupon at the rate of 10.15% per year if each ETF closes at or above the coupon barrier, 70% of the initial level, on the relevant observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par of $10 plus the coupon if each ETF closes at or above the initial level on any quarterly observation date after six months.

If the notes are not called and the final level of each ETF is greater than or equal to the downside threshold level, 60% of the initial level, the payout at maturity will be par plus any final coupon. Otherwise, investors will lose 1% for every 1% that the worst performer declines from its initial level.

52-week high

Steve Doucette, financial adviser at Proctor Financial, said he liked the terms of the notes but was skittish about the energy ETF.

“Energy stocks have been going through the roof. The valuation on the XLE has skyrocketed,” he said.

The Energy Select Sector SPDR, which trades under the ticker “XLE,” has jumped 80% from its 52-week low of August. It hit a five-year intraday high on Thursday at $81.51.

“[This ETF] fell on its face two years ago and it’s coming screaming back with inflation,” said Doucette.

“It’s a worst-of. I’m not going to guess what your exposure is going to be at the end. But given the high valuation of energy stocks and the volatility of sector, I don’t think I would want to do this note.”

Good terms

The implied volatility of the Energy Select Sector SPDR fund is 37.49%, which is much greater than the SPDR S&P 500 ETF Trust at 18.37%.

Volatility measures the amplitude of price fluctuations in a given timeframe whether up or down.

“It’s a shame because the terms are pretty good. 10.15% is a great coupon. And five years out, what are the chances that you’re going to breach that 60% barrier? I would say the odds are slim,” he said.

Roller coaster

But energy stocks are highly correlated with oil prices, whose fluctuations can be steep and unpredictable, he said.

Looking at a long-term chart of the Energy Select Sector SPDR, he spotted significant price moves.

“It’s such a volatile sector. XLE hit $100 in June 2014. From there it dropped 80% in March 2020. That’s a big drop,” he said.

The June 2014 level marked an all-time high since the fund’s inception in December 1998.

“You’re really betting on something pretty risky. We might be peaking right now, and you could get caught in a major drawdown. I wouldn’t be comfortable with this ETF,” he said.

Finding the right mix

The difficulty with worst-of is to find underliers with enough volatility to provide competitive yields, he said. But too much volatility for a fixed-income substitute would not be appropriate, he added.

Alternatively, issuers may put together non-correlated underliers to boost the coupon.

The coefficient of correlation between the two underlying funds is 0.66.

“It’s not very high and that’s probably why you get those neat terms,” he said.

But Doucette’s main concern was the volatility of the energy fund.

“I would try to find another underlying and give up some of the coupon if necessary.

“Problem is 90% of the worst-of are on the three U.S. indices. They’re correlated and you get very low coupons.

“I wish issuers would be more creative,” he said.

Doucette said he could consider reducing the coupon down to 9% for a less volatile alternative to the Energy Select Sector SPDR ETF.

Coupon at risk

Investors are not just subject to the risk of losing principal at maturity but also to the non-payment of the coupon when the 70% coupon barrier is breached.

“That’s also a concern,” he said.

“You could breach that 30% barrier a few times, which really reduces your income. A solution to that is a memory coupon. We do like those. That way if we miss a coupon, we catch it back if it comes back. There’s no guarantee in that either, but it’s a little bit better.”

Uncertainty fuels autocalls

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was more optimistic about the energy sector. He also liked the terms.

“The market doesn’t have a clear direction. There are bullish signals. There are bearish signals as well. I think that’s why we’re starting to see a lot more of the autocall notes. There’s a lot of uncertainty,” he said.

“I like the coupon on this though I think there’s a good likelihood the note will be called.

“If so, 5% return in six months or 10% per annum is very good. I’m happy with that short-term return.

“I’m also good with the 60% barrier at maturity.”

Bullish

Medeiros said the 0.66 coefficient of correlation between the two underliers was relatively high.

“You would expect the correlation to be much lower if you did a holding analysis,” he said.

He was referring to the modest presence of energy stocks in the broad index.

The energy sector represents only 4% of the SPDR S&P 500 ETF.

“So, I think the correlation is due to total market moves, not the holdings,” he said.

While energy stocks are “not cheap,” Medeiros remains bullish on the sector.

“As long as we persist in giving up our fossil fuel independence, energy stocks and oil prices will continue to rise.

“Demand is going up and we’ve cut off supplies. This trend if it goes on is clearly bullish,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

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

The notes settled on Thursday.

The Cusip number is 48133B286.

The fee is 2.25%.

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