JPMorgan's $22.2 million notes tied to MSCI AC Asia ex Japan, S&P 500 introduce unusual payout

By Emma Trincal

New York, March 7 - JPMorgan Chase & Co.'s $22.2 million of 0% return notes due March 20, 2013 linked to the capped upside return of the MSCI AC Asia ex Japan index and the downside return of the S&P 500 index caught the eyes of several market participants not just for its size but because of its peculiar structure, sources said.

The notes do not offer principal protection, and the underlying is not a basket, according to a 424B2 filing with the Securities and Exchange Commission.

The notes provide the opportunity to receive a capped return that will reflect any appreciation of the MSCI AC Asia ex Japan index, the "upside index," up to a 45% cap.

At the same time, investors are exposed to any depreciation of the S&P 500, which is the "downside" index.

As a result, investors are not exposed to any depreciation of the MSCI AC ex Japan index while they also receive no benefit from any appreciation of the S&P 500.

Intriguing structure

"You're not tied to a basket, because you add up the returns," a sellsider said.

The payout at maturity will be par plus (a) the return of the MSCI AC Asia ex Japan index, subject to a maximum of 45% and a minimum of zero, plus (b) the return of the S&P 500, subject to a cap of zero.

"These deals have been done before but never on a big scale. I'm not sure people have even heard about it," the sellsider noted.

Sources found several problems with the structure, beginning with its complexity.

"It's a very confusing deal," an industry source said.

"You have to hope both indexes go in your direction or if one goes in your direction and the other not, you want the one going your way to go up more than the other going the opposite way."

Charting the outcome

"Clearly, this is not a straightforward deal. It's pretty intriguing," a market participant said.

He looked at different scenarios based on whether the two indexes would be correlated to one another or not.

"You add correlation risk to the picture," he said.

"First scenario: you could have both indexes up, in which case you get a positive return up to 45%. That's the best scenario. You can live with a 45% cap on two years. That's pretty good.

"Second, they could both go down. You can't lose on the MSCI since you're only exposed to the upside for this one, but your exposure to the downside on the S&P 500 is unlimited. So you're going to incur a loss.

"Third, the MSCI Asia ex Japan is up but the S&P 500 is down. Here, the outcome is unknown. It depends on whether the gains on the capped upside index can offset the losses in the S&P 500.

"Finally, you have a neutral scenario if the MSCI is down and the S&P is up. Then it's a zero-sum game since you can't take [a] loss from the upside index and you can't win from the downside index."

U.S. to the rescue

The market participant said such a product would not be for everyone.

"It would present challenges to explain to the retail customer. I would be hard pressed to say who the product might have been designed for," he said.

"If you're bullish on Asia, why not buy the ETF? You wouldn't be capped and you would receive the dividends," he added.

"With this, you have more ways to lose money.

"The only reason I would see why someone would invest in this would be if you're bullish on Asia and want to protect yourself in case you're wrong by hoping that the S&P 500 would bail you out.

"If the MSCI is down, your downside is limited to zero. If at the same time, if the S&P 500 is up, you're hedged. I guess that's the idea. Zero would be the best outcome you could get if you're wrong on your bullish bet on Asia."

Subtle hedge

The sellsider agreed with the idea, explaining why it may make sense for an investor bullish on Asia to employ those notes as opposed to taking a long position in the equivalent ETF.

"It's a bullish play on Asia," he said.

"Theoretically, you put that type of investor in the ETF. But this investor may be worried about the downside exposure.

"What the structure does here is give you the upside exposure you want but with a downside exposure to something that's perceived as less risky.

"So if there's a crash in Asia, instead of being exposed to Asia, you're exposed to the U.S., which supposedly is a less volatile market, a market that could help you absorb some of your losses.

"It's another way to add value. You take a bullish bet on a more speculative market, but you sort of hedge part of the risk by getting exposure to a less risky asset class."

J.P. Morgan Securities LLC was the agent.

Fees were 1%

The Cusip number is 48125VQQ6.

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