JPMorgan links notes to crude oil index; notes attract moderately bullish investors, adviser says

By Kenneth Lim

Boston, Jan. 5 - JPMorgan Chase & Co.'s planned crude oil-linked accelerated growth notes are likely to attract investors who are optimistic about the price of oil in the medium term, an investment adviser said.

JPMorgan links to oil

JPMorgan plans to price two series of buffered return enhanced notes linked to the JPMorgan Commodity Curve Index - Crude Oil Excess Return.

The first series is due March 3, 2010. At maturity, it will pay par plus 1.5 times any gain in the underlying index, subject to a maximum total payout of 129% to 132% of the principal. The exact return cap will be set at pricing.

If the index declines by up to 15% from its initial level, investors will receive par. Investors will lose 1% for every 1% that the index declines beyond 15%.

The second series is due April 30, 2010. The notes in this series will also have an upside participation rate of 1.5 times, with a maximum total payout capped at 131% to 134% of the principal. The buffer amount is also 15%.

Highly volatile commodity

Crude oil could be an interesting commodity to look at right now because of its recent volatility spike, the adviser said.

"Anytime there's an increase in volatility, that makes it interesting just from the perspective of being able to structure some kind of an investment strategy around it," the adviser said. "Maybe you think oil prices are going to go down further; then, you'd look for bear products. Or, [if] you're neutral on oil prices, maybe you'd look for absolute return products. If you're optimistic, you can look for these kinds of leveraged upside products.

"But it's that volatility that makes those products attractive. They allow the issuer to offer a 150% leverage on the upside and a 15% buffer. Certainly, if you think that the price of oil will increase over the next 12 to 15 months, you might be interested in products like these."

Investors who buy the product will likely be moderately bullish about the product in the medium term, the adviser added.

"Your timeframe is the next 12 to 15 months," the adviser said. "You'll expect that oil prices will hit bottom at some point during that time. Ideally it hits bottom in February and just keeps climbing after that, because if it only finds the bottom in January 2010 and then starts to pull higher, you might get back only very low returns, which would be a loss in terms of opportunity cost."

Capital at risk

Investors should be aware that they could lose up to 85% of their capital, the adviser said.

"It's a buffer structure, which means you can lose some of your capital if the index falls by more than the buffer," the adviser said. "There's also a point-to-point risk, which is your payout is calculated based on two points regardless of how the index performed in the middle. If we stick to oil, let's say you bought this in January 2008, it doesn't matter that oil hit a high in the middle of the year if ends up lower when the product matures in 2009."

The risk of an issue default must also be considered.

"We can't say it enough," the adviser said. "It has always been an important consideration, even if many people forgot how important it should be."

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