JPMorgan’s return notes tied to November 2017 WTI crude offer uncertain benefits, sources say

By Emma Trincal

New York, March 24 – JPMorgan Chase & Co.’s 0% return notes due Dec. 27, 2018 linked to the November 2017 WTI crude oil futures contract would almost be a delta one product if it were not for a tiny extra return, which sources found to be negligible.

The payout at maturity will be par plus the return and $0.80 for each $1,000 principal amount, according to a 424B2 filing with the Securities and Exchange Commission. This fixed return, dubbed “additional amount,” is the equivalent of a 0.08% buffer. The prospectus warned of the downside risk in the following terms:

So small

“Because the additional amount is 0.08%, if the final contract price is less than the initial contract price by more than approximately 0.08%, you will lose 1% of the principal amount of your notes for every 1% that the final contract price is less than the initial contract price by more than 0.08%.”

As a result investors may lose up to their entire principal minus 80 cents, the prospectus said.

Buysiders discounted the tiny amount, saying that overall investors were fully exposed to the downside.

“That 80 cents doesn’t add much value to the notes,” said Steve Doucette, financial adviser at Proctor Financial.

“The question is: are you bullish on the WTI? You have to go back to the drawing board and find out.

“Obviously you want to be a bull because the 0.08% buffer doesn’t add much on the downside especially with an asset class as volatile as oil.

“Why are they even adding this moving part, I don’t know.”

Volatility

In the last year, WTI crude oil futures have followed a bearish trajectory. From a high of approximately $65 a barrel in May, the price of the commodity dropped by more than a half by Feb. 11 to $31. Since then, oil prices have rallied, jumping to nearly $42 on March 18. Over the past few days, however, prices have drifted downward again, falling below the $40 mark on Thursday, which represent a 6% decline in just one week.

“With oil jumping up and down constantly, I’d probably leave this note and trade futures, although I don’t buy futures,” he said.

“But if you’re bullish for the next 18 months, why not buy a futures contract that will get you there?

“We’ve seen terrific notes recently giving you leverage on the upside and absolute return on the downside.

“I don’t really see the benefits with this one. I can’t imagine who’s actually buying this.”

Too soon

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was also skeptical.

“I wouldn’t try to oversell the 80 cents buffer,” Medeiros said.

He objected to the deal based on the one-to-one exposure with no buffer or leverage. The timing of the trade was also a consideration.

“I think the WTI rally is overdone. We’ll see a pullback testing the $35 level approximately. We’re probably not going to see much upside before the summer.

“Once we can start to draw down some of the excess reserves in oil we’ll be able to begin to see some consistency in the price.

“The recent run-up is ahead of itself considering the macroeconomic factors behind prices, which are still not favorable. I’m talking about high inventories and a struggling Chinese economy, among other things.

“So I would probably wait. It’s going to pull back for sure. I don’t think the 80 cents kicker is enough of an incentive to go into a note without another protection.”

Avoiding margins

Matthew Bradbard, director at RCM Alternatives, a futures brokerage, said that he prefers trading oil short-term but that the note format, with a $1,000 minimum may serve the needs of investors with smaller portfolio sizes who might be less prone to use the leverage required to buy futures.

Futures traders need to have a large enough balance in their account to be able to initiate and maintain margin requirements.

“I see WTI trading between 55 on the upside and 30 on the downside,” said Bradbard.

“I don’t think the replication strategy is a bad one, especially for a small investor. After all anyone trading futures needs much more than $1,000.”

But investors with small accounts also had alternatives such as exchange-traded funds. He mentioned the United States Oil Fund or “USO” as commonly named per its ticker symbol, which is one of the most liquid ones.

“It’s not a good example though because the USO isn’t good at tracking futures.”

One of the pitfalls of ETFs replicating futures contracts is that rolling contracts month after month can generate a cost called negative roll yield, which ultimately erodes the returns. This happens when the futures curve is in the so-called “contango,” a situation when longer-dated contracts are more expensive than the spot price.

“At the same time, why buy a note with no protection, no delta? You’re giving up liquidity for not much,” he said.

“I’m much more of a trader. Oil is at 40, goes up to 50 and then down to 30... I’d much rather buy at 40, short at 50 and cover at 30.”

J.P. Morgan Securities LLC is the agent.

The notes will price on March 24 and settle on March 31.

The Cusip number is 48125U3F7.

© 2015 Prospect News.
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