JPMorgan’s $4.75 million digital notes on WTI offer deep barrier, attractive timing

By Emma Trincal

New York, June 9 – JPMorgan Chase Financial Co. LLC’s $4.75 million of 0% trigger in-digital notes due Sept. 19, 2024 linked to a WTI crude oil futures contract offer an attractive level of downside protection at a discounted entry price, which should increase the odds of earning the double-digit digital return paid to noteholders.

If the price of crude finishes at or above its 60% barrier, the payout at maturity will be par plus the digital return of 19%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will be fully exposed to any losses.

Entry level

The underlying contract on the trade date closed at $71.74 a barrel on the New York Mercantile Exchange, setting the barrier level at $43.04.

“It’s a good entry point,” said Clemens Kownatzki, finance professor at Pepperdine University.

At $71.74, the initial price is 41% off the $121 high of one year ago, he noted.

The barrier offered an extra margin of safety.

“The 60% level is pretty low. You would have to see crude oil prices drop to the 40’s, which we haven’t seen since 2020.”

Citing the International Energy Agency (IEA), which stated that oil prices retreated in April and May due to recession concerns, Kownatzki argued that the market perception may be overly pessimistic.

April 2020

Some of the fears may also be related to an aberrant phenomenon, which occurred in April 2020 when the May futures contract briefly went negative, he said.

“It was the onset of the Covid pandemic. Everybody wanted to sell, and no one wanted to buy,” he said.

“The price of an oil futures contract all of a sudden plunged into negative territory. People had never seen this before. It was scarry.”

But the phenomenon was not as irrational as it appeared to be.

“It really was a technical issue associated with the futures market, something that could never happen with spot prices. No one wanted to take delivery,” he explained.

“It was a shocking event though and it spooked the market. Traders to this day still remember it.”

Backwardation

In contrast, another technical aspect of the futures market is favorable to investors.

“The oil futures curve is in backwardation. You can pick up some extra yield,” he said.

He was referring to the price of rolling futures contracts when the futures curve is negatively slopped, which is known as “backwardation.” When nearby contracts, which are sold, are pricier than longer-dated contracts, which have to be rolled into, the roll will generate a positive yield. By opposition, a market is in “contango” when short-term contracts are cheaper than those further down the curve, causing the position to “lose” money on the roll.

In addition, the fundamentals of the oil market are relatively bullish, he said, citing the recent IEA forecast.

“They see demand rising, including from China,” he said.

“This 60% barrier is very generous, especially given that current prices are somewhat depressed. I don’t see how oil could fall below $43.”

A drop in oil prices above the barrier level would allow noteholders to receive the 19% digital return.

“With a barrier that deep, you could significantly outperform,” he said.

Demand is up

Kownatzki pointed to day-to-day signs of a renewed demand for oil.

“Airports are extremely crowded in the U.S. but also worldwide. It takes much more time to go through security now. Lines are long because the flow of passengers is much greater. Flights are delayed. All these things suggest a robust demand for travel. It’s not just the airlines. People drive too. Overall, oil consumption is up,” he said.

This begs the question of why prices have been down over the past 12 months even if recent OPEC+ output cuts have generated some short-term spikes.

Kownatzki brought up the psychological impact of the war in Ukraine.

“At the beginning of the war last year, supply constraints led to steeper prices for oil and natural gas. As sad as it is to say, the market is no longer paying attention to this horrible war dragging on. People don’t care. The fear factor is gone and with fear receding, prices have been falling,” he said.

The ‘R’ word

Another important factor is a persisting concern about a recession despite recent economic data pointing to a brighter picture.

“Crude oil prices are very much sentiment-dependent. Most analysts and economists continue to predict a recession as a result of the Fed hiking interest rates. Also, China is sending some conflicting messages as they have not yet fully recovered,” he said.

But Kownatzki was skeptical.

“We have been forecasting this recession for a while. This is the most talked about, the most predicted recession ever. But when you look at the last job report, you get a different impression,” he said.

The May employment report showed 339,000 new jobs and an unemployment rate of 3.7%.

“Where is the recession? These are full employment figures. The trucks are on the highways. There’s a lot of economic activity. It doesn’t look like we’re at the onset of a recession,” he said.

Structure

Based on those macroeconomic, fundamental and technical factors, the note offered a high probability of success, he said.

The terms of the notes helped as well.

“It’s a good structure.

“You have a pretty steep barrier, which provides a reasonable margin of safety.

“I don’t see what’s not to like about this product. Maybe I’m just too optimistic on the energy market.

“But I see crude oil prices stay within the $60 to $80 range. I certainly don’t see prices going down below $40, especially when you start at a price that’s almost half of what it was a year ago.

“It’s a very decent trade,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

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

The notes settled on Thursday.

The Cusip number is 48130Y636.

The fee is 1%.

© 2015 Prospect News.
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