JPMorgan’s $3.28 million digital contingent buffered notes offer rare direct access to oil

By Emma Trincal

New York, May 16 – JPMorgan Chase Financial Co. LLC’s $3.28 million of 0% digital contingent buffered notes due June 1, 2020 linked to a WTI crude oil futures contract provide a direct exposure to oil for investors willing to play around the gyrations of the volatile asset.

If the final contract price is greater than or equal to the initial price or less than the initial price by up to 30%, the payout at maturity will be par plus 10.02%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will be exposed to oil’s decline from the initial price.

Equity proxies

Most investors betting on oil prices have used structured notes tied to energy stock funds, such as the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund or the Energy Select Sector SPDR fund, according to data compiled by Prospect News.

Investors seeking pure commodities exposure via structured notes have been out of luck this year whether the target is oil, a broad commodities benchmark, or gold.

For gold as with oil, the most common underliers are equity funds. The VanEck Vectors Gold Miners exchange-traded fund has been leading the pack.

Vanishing asset class

Overall, the volume of commodity-linked notes offerings this year amount to a meager $105 million, an 80% drop from $534 million during that time last year. The deals are fewer as well: 15 this year versus 90 a year ago, according to data compiled by Prospect News.

The size of JPMorgan’s recent oil-linked note, which priced last week, suggests a possible reverse inquiry from an investor, sources said.

Range bound

“This reflects a particular view. You believe oil will be down a little bit. You pick up some excess return. If it goes up, you still get 10%,” said Steve Doucette, financial adviser at Proctor Financial.

“You’re hoping that it will stay in the range. If it does, you can capture that 10%.

“Problem is your maximum return is 10% and your downside is unlimited.

“Once you breach that 30% barrier, you can get hit pretty hard.

“You’ve got to be comfortable with that.”

Doucette said he would have to do more research to see how the price of oil has moved in the past year.

Geopolitical events have spurred a rally after attacks on Saudi Arabian oil tankers on Tuesday. Saudi Arabia has accused Iran of being behind the attacks.

Barrier

Looking back on a wider timeframe, oil began rising two years ago and peaked in early October, gaining 60% over that 15-month period. Just as the stock market began to pull back in early October, WTI crude oil futures followed suit only at a more drastic pace, down more than 41% from a high of $75 a barrel in the beginning of October to $44 in December.

Both oil and stock prices have rallied this year. WTI contracts for June settlement closed at $63.14 on Thursday, up 1.84% for the day. Prices have soared 35% since January.

“Everybody knows that oil prices are very volatile. The 30% barrier can be easily breached,” Doucette said.

“It happened last year. You really have to be confident that it’s not going to happen again in the next 12 months.”

Diversification

For asset allocators, commodities are often perceived as showing a low or negative correlation to stocks, which adds value to the portfolio.

But Doucette questioned the divergence between the two asset classes.

“You have to question that too,” he said.

Plotting the S&P 500 index on a chart with crude oil showed that both asset classes tend to move closer together than one would expect.

“If we’re looking for non-correlated assets, what happens if we get into a recession? Oil prices are going to drop. At that point there will be a strong correlation,” he said.

“Oil is unpredictable. It’s the result of supply and demand, and any threat on supplies can have a huge impact on prices. Right now we have a rally, but it can go either way.

“You really have to do your due diligence and look for those black swans that can come to haunt you.”

Bullish view

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was bullish on oil and liked the notes for the guaranteed 10% gain even if the market is down by no more than 30%.

“I do like the digital component of this note. A 10% return in one year with a chance to outperform on the downside within a wide range seems attractive to me,” he said.

The main question investors need to ask themselves is whether they believe that 30% is enough protection.

“This is key. In order to invest in this, you have to be reasonably confident that crude oil prices are not going to breach that 30% barrier,” he said.

“Right now in the context of the uncertainty that dominates the Middle East, I don’t see it dropping more than that.”

While no one know how the current situation in the Middle East will evolve, there is enough uncertainty to suggest possible disruptions in oil supply leading to oil prices rallying rather than falling, he said.

“I just don’t see a scenario where oil would go down 30%,” he said.

“And if oil goes up, I would be comfortable with the digital offer.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes (Cusip: 48130UQY4) priced on May 10.

The fee is 1%.

© 2015 Prospect News.
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