JPMorgan’s $11.8 million trigger notes tied to oil & gas ETF offer short-term bet for bulls

By Emma Trincal

New York, Jan. 14 – JPMorgan Chase & Co.’s $11.8 million of 0% trigger jump securities due July 14, 2015 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund offered an attractive fixed payment for investors who believe oil companies should recover over the next six months.

If the fund finishes at or above the initial share price, the payout at maturity will be par plus the upside payment of 19.50%, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the share price falls by up to 10% and will be fully exposed to losses from the initial price if the fund finishes below the 90% downside threshold level.

Tactical play

The ETF, which trades on NYSE Arca under the ticker symbol “XOP,” comprises 91 stocks of companies in the oil and gas exploration and production sector of the S&P Total Markets index.

“If you think oil is going to stabilize it seems like a pretty high coupon,” a structurer said.

“XOP is down 50% off its high of June 2014.

“As long as you don’t see a drop of more than 10% you have the potential to earn a pretty high return over a short period of time.”

A market participant agreed. The reward was high for such a short maturity.

“It’s a pretty high return they give you that reflects what’s going on with the price of oil going down. It’s a tactical play based on the level of volatility for these stocks,” he said.

Time value

The longer the time an option is sold for, the more risk there is because investors are “selling more time out” and therefore will collect more premium, explained Joe Bell, senior equity analyst at Schaeffer’s Investment Research.

“Yes, it looks like you’re getting a lot on the upside. But it’s a volatile trade,” he said.

“The ETF is already down 45% in the last six months. Paying 19.5% seems like a lot but it’s not risk-free. The risk is clearly that the fund could go down by more than 10% six months from now.”

Short interest has been on the rise for some of the major oil companies such as Schlumberger Ltd., Halliburton Co. and Baker Hughes Inc. although the last two weeks have seen a reduction in the short interest for the ETF itself, Bell said. The short interest ratio is a sentiment indicator defined as the short interest divided by the average daily volume of a stock.

Too short

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said the short duration was actually his main objection along with the structure itself.

“I wouldn’t do it. I think oil is going to recover, perhaps as soon as in the second quarter. But given the structure, six months would be too short for me,” he said.

“The 10% threshold could be breached easily and if oil prices take longer to recover, you are taking the loss without owning the security.

“If it was a reverse convertible, I would probably go for it. Even if I was put the stock, I wouldn’t mind. I could hold it a little bit longer because my outlook on oil is bullish. But I wouldn’t do it with this digital. Unlike a reverse convertible, this type of structure would force me to realize a loss.”

Fit for sideways

A general view is that oil is not going to show a strong turnaround and that the market is more likely to trade range bound than rallying strongly, said the structurer.

“If that’s true, it could be an interesting trade. The stock may have expanded on the larger part of its downside, [and] the sell-off may at this point be overdone. On the upside, the price appreciation may be muted. In that scenario, the 19.5% digital in six months along with that 10% protection seem pretty attractive.”

The notes (Cusip: 48127R305) priced on Jan. 9.

The fee was 1.75%.

J.P. Morgan Securities LLC is the agent with Morgan Stanley Wealth Management handling distribution.

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