JPMorgan's autocallables linked to iShares Russell ETF reduce reinvestment, downside risks

By Emma Trincal

New York, Feb. 23 - JPMorgan Chase & Co.'s autocallable contingent interest notes due Feb. 27, 2015 linked to the iShares Russell 2000 index fund should appeal to conservative income-seekers, sources said, because the structure limits reinvestment risk and protects the downside through a low contingent barrier.

"This is a fairly attractive structure," said Eric Greschner, portfolio manager at Regatta Research & Money Management.

"I like the one-year call protection and the defensive barrier."

If the fund closes at or above the 55% trigger level on any quarterly review date, the notes will pay a coupon that quarter at an annualized rate of 7%, according to a 424B2 filing with the Securities and Exchange Commission.

If the fund closes at or above the initial share price on any review date other than the first, second, third and final review dates, the notes will be called at par plus the coupon.

If the notes have not been called and the fund finishes at or above the trigger level, the payout at maturity will be par plus the coupon. Otherwise, investors will be fully exposed to the decline.

One year no-call

Greschner said he liked the fact that no early exit can occur during the first year.

Even if the notes were to be called, the term of the note could never be shorter than one year, according to the prospectus, which prohibits calls until the fourth review date.

"Having products that are callable too quickly is a real problem for a portfolio manager," he said. "I have turned down notes just for that reason.

"We have a huge volume of information to process, and the autocallable frequency is something we need to watch carefully for the sake of time efficiency."

An investor in this three-year product should look at maximizing returns by staying invested as long as possible, he said.

"A 7% annualized return is very attractive compared to corporate bonds that are not paying anything," Greschner said. "You wouldn't want to be called right away and have to replace that coupon."

Clipping the coupon

Sources noted that this type of autocallable product is slightly different than the traditional autocallable format, in which the call and the payment of a call premium always occur simultaneously.

"I like the fact that you can collect the coupon without necessarily getting called," said John Farrall, director of derivatives strategies at PNC Wealth Management.

"You might pick up several coupon payments early on. For an income-oriented investor, getting a coupon early is an attractive feature."

The underlying exchange-traded fund tracks the performance of the Russell 2000 index, the small-cap U.S. equity benchmark.

While the ETF has reached new highs of late, sources said that the 55% barrier is low enough to give investors a reasonable level of comfort.

Playing defense

"If I invested in this note, I would not want to get called and I would not want the barrier to be hit. I would want to collect the coupon as often as possible and maximize my return," said Greschner.

"This is why I like this 55% trigger price. It's a very significantly defensive structure. Even if the barrier is conditional, this is a substantial downside barrier. That's a plus."

The ETF, which closed at $82.88 (NYSE Arca: IWM) on Thursday, is up 12.35% year to date and has gained 36% over the past five months.

"The fund has already ramped up a lot. But from a chart's perspective, the barrier is below the low," said Greschner.

"I would expect the Russell to take a pause, perhaps to go down a little bit. But if it's down 10%, what do I care?

"I would feel very comfortable that the barrier would not be violated."

Farrall agreed, saying that the trigger price was set at a low level.

"Breaching the barrier would take you pretty close to the lows of 2009. You still have a long way to go," he said.

J.P. Morgan Securities LLC is the underwriter.

The notes will price on Friday and settle on Wednesday.

The Cusip number is 48125VNY2.

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