JPMorgan's $20.59 million capped knock-out notes linked to Apple stock seen as 'nuanced' bet

By Emma Trincal

New York, Nov. 10 - JPMorgan Chase & Co. priced another knock-out offering with a one-year tenor linked to a stock, prompting a source to guess that the notes, all very similar in terms, may have been designed for one particular client.

JPMorgan brought to market $20.59 million of capped knock-out notes due Nov. 23, 2011 linked to the common stock of Apple Inc.

The deal comes on the heels of several similar knock-out transactions with the same maturity also distributed by JPMorgan.

For instance, this agent sold $107 million of capped knock-out notes due Nov. 23, 2011 linked to the S&P MidCap 400 index on the behalf of Deutsche Bank AG, London Branch last week.

In addition, JPMorgan placed $14 million of index-linked trigger notes tied to the mid-cap benchmark for Goldman Sachs Group, Inc.

A knock-out structure gives investors the benefit of principal protection subject to credit risk as long as the underlying index or stock does not fall below a trigger.

If Apple stock closes below 73.4% of its initial share price during the life of the notes, the payout at maturity will be par plus the stock return, which could be positive or negative, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, the payout will be par plus the greater of the stock return and 10%.

In each case, the payout will be subject to a maximum return of 25%.

Triggers and buffers

Commenting on the popularity of this series of trigger note offerings, an industry source said, "Triggers reveal more confidence in the market than buffers. Both are for people who want some protection on the downside. But a trigger is more bullish."

Once a trigger event occurs - and it can occur anytime during the life of the notes - investors are exposed to the full decline of the index or stock without any protection, he explained.

In contrast, a 25% buffer, for instance, will absorb the first 25% that the index declines.

With the Apple deal, as with the similarly structured notes, the issuer chose to offer a reference asset that has attracted bulls, noted a sellsider.

"No one wants to bet against Apple. Everybody is going along for the ride," he said.

Technical support price

But Eric Greschner, portfolio manager at Regatta Research & Money Management, believed on the contrary that the notes were designed for investors who are not overly bullish on Apple given that the return is capped at 25%, with or without a trigger event.

"If you have a moderate outlook on Apple, it's fairly attractive. It's built for that, and it's suitable to meet that objective," Greschner said.

"The cap is higher than a reverse convertible coupon.

"But you can't be too bullish or you'd buy the stock outright.

"Obviously you can't be bearish either."

Greschner said he was intrigued by the 26.6% knock-out buffer amount.

"In a typical offering, your percentage is going to be a round number, usually 25% or 30%," he said.

Looking at a chart of the stock, he said that the trigger price of 73.4% of the initial price was below the technical support of Apple's share price from April to September.

A support level in technical analysis is a price from which the stock tends to bounce back instead of declining further.

"Investors are betting that the barrier will not be violated as buyers have stepped up in the past at that price," he said.

Nuanced strategy

"They're not selling it to retail because it's so specific. Putting the trigger price below the support level is something you may look for when you're not buying off the shelf. Usually, that's what we do in order to limit the risk. It's not a retail product. If you had to show it to retail, from a sales and marketing standpoint, it would be confusing to explain," he said.

In addition, Greschner said that trigger notes are "complicated structures reflecting very complex strategies."

"If the knock-out occurs, it's a reverse convertible," he said. "And if it doesn't, it's a principal-protected note with a minimum return."

In this particular deal, the minimum return of 10% is "high" he said, and investors pay for it with the 25% cap.

"It's a fairly high cap on a short duration," he added.

Overall, the strategy pursued by investors in the notes is "fairly nuanced," he said.

"It shows a specific strategy and a specific probability assigned to it. But it's based on the expectation that the underlying stock price is not going to be very volatile."

Looking at the series of knock-out deals recently priced by JPMorgan, Greschner said, "They seem very tailored to me. They have certain things in common: the maturity, the structure, the strategy.

"And with this one, there's technical analysis included in the construction of the structure.

"I would argue in favor of a particular client."

J.P. Morgan Securities LLC was the agent for the notes (Cusip 48124AW78).

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