JPMorgan’s contingent interest autocall tied to index, fund includes high volatility in the mix

By Emma Trincal

New York, Nov. 17 – JPMorgan Chase Financial Co. LLC’s autocallable contingent interest notes due Nov. 21, 2019 linked to the lesser performing of the SPDR S&P Biotech exchange-traded fund and the S&P 500 index offer an attractive contingent coupon rate and a deep barrier, but the underlying volatility of one of the underliers raises concerns about risk, according to buysiders. The two main negative outcomes would be not getting paid the full amount of the coupon and losing some principal at maturity.

The notes will pay a contingent quarterly coupon at an annual rate of at least 8.55% if each underlying component closes at or above its coupon barrier level, 50% of its initial level, on the review date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each component closes at or above its initial share price on any quarterly review date other than the first, second, third, fourth, fifth and final review dates.

The payout at maturity will be par unless either component finishes below its 50% trigger level, in which case investors will be fully exposed to any losses of the worse-performing component.

50% barrier

“You have a very large barrier. If you’re confident than none of those two indexes can drop more than 50%, it can be used as either fixed-income or equity substitute because an 8.5% return is pretty decent,” said Steve Doucette, financial adviser at Proctor Financial.

“You have the credit risk, which is true for all structured notes, and the call risk, but that’s the case with all these autocalls.”

The worst-of structure requires both underliers to close at or above the 50% coupon barrier. At maturity, both have to close above the 50% trigger level in order for investors to get repaid their entire principal, he noted.

The fund

“I would have to do some research on the biotech fund. By definition, these are extremely volatile stocks,” he said.

The top holdings in the fund are Ionis Pharmaceuticals Inc., Tesaro Inc., Sarepta Therapeutics Inc., Incyte Corp. and Exelixis Inc. Celgene Corp. and Biogen Inc. are also among the top 10 constituents.

The ETF has an implied volatility of nearly 37% versus 13% for the S&P 500.

This year so far, the SPDR S&P Biotech ETF has lost 5.3% while the large-cap benchmark is up 7%.

Over the past year, the fund has dropped nearly 3%. But its share price has surged by over 222% in the past five years.

“You could easily bust the barrier going forward, or one of the barriers,” Doucette said.

Buying the notes would require having a high risk tolerance.

“I’ve done those worst-of before, and I like them. But this one is a bit different,” he said.

“Do you want anything that’s really volatile? That’s part of the reason you get 50% on the downside,” he said.

Principal

“I’d be somewhat concerned. You have the coupon at risk and the principal at risk,” he said. “My biggest concern would be the principal amount I get at the end.”

Even with a deep barrier, the risk of losing at least half of one’s investment seemed too high.

“Three years out, if you bust the barrier it’s a heck of a loss for giving up your upside,” he said.

When Doucette purchases autocallable worst-of deals, he makes sure to pick indexes that are much broader.

“We may have married the S&P 500 with some international indexes, like the S&P and the Euro Stoxx 50. We may have had a little bit less protection but also less volatility and perhaps a higher coupon,” he said.

Doucette said he would have to do some research on the biotech fund. He would also have to see whether the use of a highly volatile underlier and a deeper barrier made sense with these types of payout structures.

“I’d probably be a little bit hesitant after I do my due diligence,” he said.

High P/E

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he did not like the intricacy of the structure. He also felt uncomfortable with the uncertainty around interest payments.

“I like both underliers but they’re both trading at relatively high multiples. It means that the potential for appreciation is being reduced, which is fine since the notes are capped. But it also means that you have a greater potential for losses,” he said.

Too much going on

The structure showed several “layers,” which made the investment difficult to explain and monitor.

“You have a bunch of different scenarios... the call, the coupon payments each quarter. You may be called. You may not get paid. At maturity, you have the risk of a big loss of principal. And all these outcomes depend on the performance of not one but two underliers,” he said.

“I don’t like all the moving parts.”

Medeiros said that his greater concern was the unpredictability of the income payments.

“I like the concept of using an equity security to turn it into a high-yield product. But this product combines contingency of the coupon and worst-of. With those two, it’s very hard to predict what your actual coupon rate is going to be,” he said.

Income stream

The risk of principal loss was not as much of an issue.

“I’m less concerned about the barrier at maturity because it’s a generous barrier for that timeframe, especially point to point,” he said.

“I would be more interested in an income product that would provide a more dependable income stream. I could go for something that pays a coupon at the condition that your underlying closes within a certain range. But make it one underlier, not two, otherwise it becomes a little bit too involved.”

But the product combined too many conditions and offered unpredictable outcomes.

“It’s a bit much. It would be a challenge for me to get into something like this because of the complexity,” he said.

J.P. Morgan Securities LLC is the agent.

The notes will be guaranteed by JPMorgan Chase & Co.

The notes will settle on Tuesday.

The Cusip number is 46646QAQ8.

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