JPMorgan's PLUS tied to S&P 500 seen as uncommonly short-term for leveraged notes

By Emma Trincal

New York, Nov. 13 - JPMorgan Chase & Co.'s 0% Performance Leveraged Upside Securities due May 31, 2013 linked to the S&P 500 index offer enhanced return over a short period of time - less than one year - something not very typical with leverage products, sources said.

The payout at maturity will be par plus 200% of any gain in the index, subject to a maximum return of 6.5% to 9.5% that will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will be fully exposed to losses if the index declines.

"Most of our notes are 13 months," said Tom Balcom, founder of 1650 Wealth Management.

"We typically don't have anything shorter than [that] in order to avoid taxes on short-term capital gains. But if you have an IRA account or a sheltered account, it doesn't matter."

No barrier but a cliff

For Balcom, the short tenor of the notes mattered in the current post-election context as investors are now focusing on the U.S. tax debate in Washington and the negative consequences of its potential failure.

"If you think the market will trade range bound in the next six months despite the uncertainty around the fiscal cliff, then these notes may work for you.

"But with earnings slowing down, the fiscal cliff looming out, I'd rather have some capital protection," he said.

The 6.5% to 9.5% cap was "not bad" he said, "Although I wish they wouldn't give you such a wide range."

"Also, keep in mind that you can take out 1% from that cap because your returns are tied to the price return and the S&P 500 has a 2% yield.

"If you're bullish, you're better off without the cap. And obviously, this doesn't work for the bearish investor.

"It's marketed to people who anticipate modest returns for the markets, but you have to be aware of the timing.

"With talks in Washington perhaps going nowhere, you want to hedge from that headline risk. Every day, on every news channel, it's about the fiscal cliff. It doesn't make me comfortable buying something with no downside protection at this point."

Short is cheap

Michael Iver, founder of iVerit Consultancy and former structurer, noted that only a few leveraged notes have very short-term durations as this product does, unlike reverse convertibles which often have three-, six- or nine-month maturities.

"This is a short-term leveraged note and we don't see many of those because of the tax treatment," Iver said.

Short-term capital gains are taxed at a higher rate. Most leveraged products have maturities between one year and three years, according to recent data compiled by Prospect News. The average is a little bit over two years.

But Iver said that from a pricing standpoint, it makes sense to structure those products with short tenors.

"The term structure of the S&P 500-index volatility curve is upwardly slopped. Options are more expensive as you move up the maturity curve. But on the short end, it's cheaper to create leverage.

"So you have the choice between two possibilities. Either you structure longer-dated notes with less leverage but long-term capital gains or you use a shorter maturity with lower volatility, higher leverage but then you have to deal with the short-term capital gain tax treatment," he said.

If new tax rules went into effect, investors may turn their attention to shorter-dated leveraged products, he said.

"I expect more short-term deals to come up if Washington raises tax rates on long-term capital gains," he said.

"Maybe with Obama re-elected, if long-term capital gains get taxed more, you'll see more of those six-month or nine-month deals.

"That's because it could become relatively less attractive to lock up your money in a long-term instrument. By comparison, short-term deals would no longer be so unappealing from a tax standpoint. That combined with the fact that short-term volatility is cheaper, which gives investors more leverage, and you can imagine these types of short-term deals gaining more momentum," he said.

The notes (Cusip: 46637G181) are expected to price Nov. 27 and settle three business days later.

J.P. Morgan Securities LLC is the agent.

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