JPMorgan's 9% reverse convertibles tied to Amazon could see pricing improvement, analyst says

By Emma Trincal

New York, Oct. 26 - JPMorgan Chase & Co.'s 9% reverse convertible notes due Oct. 31, 2013 linked to Amazon.com, Inc. shares may appeal to risk-taking investors familiar with the underlying stock given recent price movements around the company's quarterly loss, said Suzi Hampson, structured products analyst at Future Value Consultants.

The payout at maturity will be par in cash unless Amazon.com shares fall below 80% of the initial price during the life of the notes and finish below the initial price, in which case the payout will be a number of Amazon.com shares equal to $1,000 divided by the initial price, according to an FWP filing with the Securities and Exchange Commission.

Down and up

Amazon posted a third-quarter net loss on Thursday after the close, which pushed down the share price to $220 in after-hours trading, a nearly 5% loss for the day. But the stock rallied on Friday back up to $238.

Since its high for the year six weeks ago, the shares have lost 9%. The notes are set to price Monday.

Future Value publishes a price score that measures a note's value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 6.40 price score which is less than the average of all products at 7.07, according to Future Value Consultant's research report. The "similar products" category - which encompasses all reverse convertibles - shows a price score of 6.81, which is still better than this product, Hampson said.

"The one-year implied volatility was under 32% two days ago. Now it's about 33%. It hasn't moved that much," she said on Friday.

"Because the implied volatility is forward-looking, Thursday's selloff may not have any direct effect on it. You have to look at the expected move over the time period, which is one year with this product. However, if volatility spikes between now and Monday, you might expect the coupon to go higher especially if similar products hit the market at the same time.

"Some deals are re-priced, other are cancelled. But it doesn't happen all that much. It really depends on the price action at the date of pricing. Ultimately though, volatility is what affects the option price. You have to see a big move in the implied volatility, which has not happened so far," she said.

Barrier and outlook

Investors in the notes are seeking income, she said. They also need to be familiar with the stock and have a view on its price direction.

"They give you a 20% barrier. The value of the protection is relative. It depends on your outlook on the stock. If you think the stock has already gone down a lot for that time-period, then 20% is a good level of protection for you," she said.

"Ideally, you want to buy at a low price, with the expectation that volatility will come down so that the chances of breaching the barrier are reduced."

Hampson compared the risk profile of a reverse convertible with a direct investment in the stock.

"The reverse convertible is a slightly lower risk alternative to buying the stock itself. You have to be happy with an annualized coupon of 9% and willing to buy the shares if the barrier is breached.

"When you pick a reverse convertible instead of the stock, you're swapping some of the potential for higher return for some level of downside protection. In that regard, it's a less risky option than the direct long position in the stock.

"However, out of all the products we look at, reverse convertibles are the riskiest because they are tied to a single-stock. So the risk profile of a reverse convertible is somewhere in between," she said.

Riskmap

Future Value Consultants measures the risk associated with the product with its riskmap on a scale of zero to 10. Ten is the highest risk level and zero the lowest.

The riskmap is the sum of two risk components: market risk and credit risk.

At 4, the notes' riskmap is "quite average," she said comparing it with 4.07 for all products and 4.21 for the average of similar products.

"It's less risky than other reverse convertibles. The difference could just be that other reverse convertibles are linked to more risky underlying stocks. In any event, the difference is small.

At 0.53, the credit riskmap of the product compares favorably with 0.60 for similar products.

"JPMorgan is not the worse credit compared to other issuers," she said.

Future Value measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions - neutral assumption, high and low growth environments, and high and low volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

With a reverse convertible, the best scenario is low growth, she said. Under that assumption, investors have a 76% chance of generating a positive return against 24% chances of losing some principal. Within the gains section of the chart, the odds of generating an annualized return in the 5% to 10% bucket are nearly 74%, while on the loss part of the equation, investors have a 14.5% probability of losing more than 5% of their initial investment, she said.

Moderate return

The return score however is average, she said.

At 6.09, the notes have a return score in line with the return score of similar structures at 6.16, she said. The difference with the 6.16 score for the "all-products" category is slightly more pronounced but not significant, she said.

"It's hard to compare this product with others on the return scale because the differences are quite small," she said.

"The big difference is probably in the price score.

"It could be because the volatility has been moving against this product. Since the drawing of the deal, volatility has been rising, which would increase the likelihood of the barrier being breached, in which case you would expect more coupon. If this is the case and if this pricing does not compare well with other similar products, assuming that others will price on the same day, it's not impossible to imagine a re-pricing," she said.

Pricing

The price score and return score are averaged to obtain the overall score of the product, which represents Future Value Consultants' opinion on the quality of a deal.

The notes have a 6.24 overall score. It is less than all products at 6.82 and still inferior to 6.48, the overall score for reverse convertibles.

"This reflects a lower than average return score and price score obviously," she said.

"The return score is your potential return given a certain amount of risk.

"If volatility is moving around, it becomes more important to look at the scores on the pricing day.

"If volatility falls on that day or if for instance they decide to increase the coupon, you would expect a rise in the scores, both in the price score and the overall score," she said.

The notes are expected to price on Monday and settle on Oct. 31.

JPMorgan is the agent.

The Cusip number is 48126DEP0.

Earlier this month, JPMorgan said it would price 9% reverse convertible notes due Oct. 18, 2013 linked to Amazon.com, Inc., according to an FWP filing with the SEC. The deal was supposed to price on Oct. 16 but so far has not, according to data compiled by Prospect News. This previously announced deal was cancelled, according to the data. Those notes (Cusip: 48126DCV9) had similar terms as the new one to be priced Monday.

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