JPMorgan’s series of dual directional notes will use leverage with caps or worst-of payouts

By Emma Trincal

New York, July 2 – Absolute return notes seem to be attracting more demand, and some issuers are coming up with new devices such as caps or alternatively uncapped worst-of payouts combined with leverage. The goal is to make these types of products more appealing as people are beginning to lack conviction about where the market is heading.

A series coming up

JPMorgan Chase & Co. is an example.

The issuer has announced at least six deals that offer an absolute return payout within a wider range than usual, according to FWP filings with the Securities and Exchange Commission.

The notes feature lower barriers, which was achieved by extending maturities and other ways as well. In some offerings, the structure includes a cap and some leverage, the presence of leverage being less familiar to investors in these products, sources said.

In a pair of other notes, the issuer is able to uncap the upside and keep it leveraged by using a worst-of payout, adding a second index as a reference asset.

Both techniques – the cap and the worst-of structure – achieved buffers in the 30% to 35% range over maturities ranging from three years to five years.

J.P. Morgan Securities LLC will distribute all the upcoming offerings set to price on July 28.

Four-year note with 50% cap

As a capped structure for instance, JPMorgan plans to price four-year dual directional contingent buffered return enhanced notes (Cusip: 48125UYP1) linked to the S&P 500 index.

If the index finishes above its initial level, the payout at maturity will be par plus 1.1 times the index gain, up to a maximum return of 50%.

If the index falls by up to 30%, the payout will be par plus the absolute value of the index return.

Otherwise, the payout will be par plus the return, with full exposure to any losses.

“A 50% cap over four years, that’s 12.5% a year return. Do we think it’s a reasonable risk return with that barrier type? I wouldn’t be concerned with a 50% cap. But my concern would be how to get deeper barriers,” said Steve Doucette, financial adviser at Proctor Financial.

“If you get the barrier down, you get the potential to hugely outperform. But a 30% barrier can easily be busted through.”

Five-year note

Another upcoming capped dual directional deal (Cusip: 48125UYQ9) has a five-year maturity, the same 1.1 upside multiple, a 50% cap on the upside and a 35% barrier.

“This is an interesting structure. I wouldn’t worry about the cap of 50%,” said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

“While I’m optimistic about the S&P over a five-year period, I am not optimistic to the point that I would anticipate high double-digit returns.

“The barrier is fair on a one-to-one basis. It seems like an interesting way to position an S&P allocation.

“We could breach the 35%, but it’s point-to-point. If you look at five-year rolling periods that incorporate the crash of 2008, for instance September 2003 to September ’08 or June 2004 to June 2009, you’re still not going to hit that 35%. You may go down 35% off the highs, but from a point-to-point basis, you probably wouldn’t be piercing that barrier over a five-year period.”

JPMorgan announced two other similar five-year capped dual directional deals. One has a 50% cap and a 32.5% barrier (Cusip: 48125UYS5). The other has a 40% cap and a 30% barrier (Cusip: 48125UYR7).

Worst-of structure

Additionally, the issuer announced two other offerings of dual directional notes with uncapped and leveraged upside with the 1.1 multiple maintained. But with these deals, the return is based on the worse performing of the S&P 500 index and the Russell 2000 index

If each index finishes above its initial level, the payout at maturity will be par plus 1.1 times the gain of the worse-performing index.

If each index falls by no more than a set contingent buffer, the payout will be par plus the absolute value of the return of the worse-performing index.

Otherwise, the payout will be par plus the return of the worse-performing index, with full exposure to any losses.

The first upcoming deal is a four-year note with a 32.5% contingent buffer amount (Cusip: 48125UYU0).

The second is a three-year note with a 30% contingent buffer (Cusip: 48125UYT3).

“It doesn’t look like you get significant improvements on the barrier side by using the no-cap worst-of versus the cap on a single index,” Doucette said.

“In both cases, you’re pretty much in the 30% to 35% range. You can pick a 5% more in the barrier from 30% to 35%, but you pick up an extra year. You have to go from four to five years.

“I might take a mix. Why not take a worst-of with perhaps a five-year maturity?”

The difficult part, he said, is to make projections about the market three to five years from now.

“One of the advantages of going for a five-year is that you may give yourself enough time to see the market go all the way down and come back up,” he said.

“You pick up an extra 5% in barrier and perhaps an extra year in return.

“But all of that completely depends on your outlook. Are you more bullish four years out or five years out?

“What we know is that you can never get these nice terms on a two-year note.”

Risk management

Medeiros said he prefers the plain vanilla capped dual directional deals to the worst-of versions.

“The first one is a simple structure to understand,” he said.

“When you start getting into the worst-of payout, my concern usually is complexity. When you have too many moving parts, it’s hard to understand and manage the risk. You have too many components to be able to set realistic return expectations.”

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