Credit Suisse, JPMorgan announce 'lookback' notes in effort to offer optimal market entry

By Emma Trincal

New York, Oct. 10 - As the market is becoming more and more challenging to predict and as the end of the year is nearing, issuers are launching deals that attempt to solve the market timing dilemma faced by investors, especially when it comes to timing the entry, sources said.

One solution is the use of a lookback option, which allows investors to "look back" at the underlying index level over an observation period to get the best possible entry point. Those exotic options attempt to diminish the uncertainty associated with the timing of a market entry, sources said.

New deals

Credit Suisse AG, Nassau Branch and JPMorgan Chase & Co. have recently announced offerings of notes using lookbacks, according to filings with the Securities and Exchange Commission.

Credit Suisse priced $2.95 million of 0% optimal entry enhanced participation equity securities due Oct. 14, 2014 linked to the MSCI EAFE index, according to a 424B2 filing with the SEC.

The lookback level will be the index's lowest closing level during the two-month period beginning on the pricing date.

If the final index level is greater than or equal to the lookback level, the payout at maturity will be par plus 150% of the gain, subject to a maximum return of 17.33%. Investors will receive par if the index declines by 10% or less from the lookback level and will lose 1.111111% for every 1% that it declines beyond 10%.

Separately, JPMorgan plans to price 0% optimal entry return notes due Oct. 31, 2016 linked to the S&P 500 index, according to an FWP filing with the SEC.

The lookback level will be the index's lowest closing level during the lookback observation period, which will begin on the pricing date and end on the final lookback date. The final lookback date will be set at pricing and will be on or after Dec. 26, 2012 but no later than Jan. 26, 2013.

The payout at maturity will be par plus the index return. Investors will lose some or all of their principal if the final index level is less than the lookback level.

Sources comparing the two products said that Credit Suisse's notes are shorter in duration and have a two-month lookback period while the four-year product from JPMorgan has as a result a longer observation period of two to three months.

A more important difference, besides the use of two different equity indexes, is the existence of a 10% buffer with the Credit Suisse notes in addition to the potential lookback protection. However, those notes are capped while the non-buffered structure offered by JPMorgan is not.

Volatility down, uncertainty up

But those deals have the lookback in common, which is designed to help investors get favorable market timing conditions, the sources said, hence the term "optimal entry" used in the name of both products.

A sellsider noted that lookbacks have not been very widely used before nor have their issue sizes been big so far this year. But things may change.

"It could be that we see those deals because we have the elections coming up. We are in a continued uncertainty. The two-month [lookback] period could fit nicely if we are to expect some volatility in the short term," this sellsider said.

"In general, the lookback is a very interesting story," he added.

"The only difference with a regular deal is that instead of the initial level being the fixed reference, you pick the lowest level in the next two months after pricing.

"It gives you additional protection. We don't know how much though."

Both issuers make sure to mention the uncertainty regarding the final protection level as one of the risks to consider, saying in their respective prospectuses that investors will not know the lookback level until the end of the lookback observation period.

"It's still attractive if the index falls during that time," the sellsider said.

A lookback is an exotic option in which the strike is set after issuance. Its cost is more expensive than a vanilla option. But today's market conditions, especially the low volatility, may facilitate pricing, an industry source said.

"Some issuers may see them as timely. The strike is set two months after pricing. There's more uncertainty on the political side. Volatility is very low. In this context, a lookback is rather attractive. Volatility is low and uncertainty is high, especially when it comes to the looming political decisions to be made in the U.S. and in Europe. It's a good opportunity to buy the lookback options. They're cheap," this source noted.

Lookbacks are cheaper when volatility is low, and demand for them from investors increase when uncertainty is on the rise. Usually, uncertainty and volatility go hand in hand, but it is not yet the case in today's environment, noted a sellsider who called the current market "schizophrenic."

"People see the end of the year as volatile. It's marketing-driven," a market participant said, adding that investors could be bullish over the longer term but slightly defensive or bearish short term. Striking a deal at a lower level than the initial level could be appealing for investors holding that view, he said.

After a strong rally that pushed the S&P up by nearly 15% this year, some investors have been reluctant to sell for fear of missing out on the bullish action while others are afraid to buy at the beginning of a correction.

"It's very difficult to have a clear sight of the market," the industry source said.

"The market is up. We had a small correction in October, but fundamentally nothing has changed. In the U.S., we see no amelioration in earnings despite the good unemployment numbers. In Europe, there is even more uncertainty. Apart from the ECB, where is money going to come from? Where is the growth?"

Still small

Deals with lookback options are designed to facilitate market entry. But they are no panacea, sources said.

The JPMorgan structure for instance offers no leverage on the upside and no downside buffer in addition to a potential lookback protection. In theory, investors can still lose their entire principal, and the duration is four years.

The Credit Suisse notes have a buffer, but with the downside leverage, investors may still lose their entire investment. In addition, the cap limits the upside.

"With the Credit Suisse deal, you already have 10% [protection] built in the structure with potentially more, and that's a good feature," the sellsider said.

"The choice of capped versus no cap depends on the investment horizon. For a longer-dated note, I prefer the no cap. For the shorter ones, I'm happy to accept the cap," the market participant said.

A few deals using the name "optimal entry note" or "lookback" have priced this year, but their sizes and numbers have remained small, according to data compiled by Prospect News.

The smallest one was brought to market in July by Bank of Nova Scotia. It priced $1.55 million of capped optimal entry notes linked to the Euro Stoxx 50 index. They were distributed by Goldman Sachs.

The largest and most recent one in this group was Citigroup Funding Inc.'s $12.05 million of lookback trigger performance leveraged upside securities due July 30, 2012 linked to the S&P 500. Citigroup also issued and sold a smaller deal of $4.6 million in June.

JPMorgan sold four small deals in February, three of which were on the behalf of Deutsche Bank AG, London Branch and one was issued by Credit Suisse. Deutsche Bank's $7.17 million optimal entry return enhanced notes linked to S&P 500 was the largest of the four.

Separately, Morgan Stanley last month announced plans to price lookback entry jump securities due October 2015 linked to the performance of Brent crude oil. The notes (Cusip: 617482P81) will price in October and settle in November.

Credit Suisse Securities (USA) LLC was the agent for the Credit Suisse notes, and their Cusip number is 22546TC25.

The JPMorgan offering is expected to price Oct. 26 via agent J.P. Morgan Securities LLC and settle Oct. 31. The Cusip number is 48126DBK4.

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