JPMorgan’s PLUS tied to S&P 500 index offer high leverage, short-term play

By Emma Trincal

New York, Dec. 12 – JPMorgan Chase & Co.’s 0% Performance Leveraged Upside Securities due Feb. 5, 2016 linked to the S&P 500 index are designed for mildly bullish investors who want to capture extra returns over a short period of time, said Tim Vile, structured products analyst at Future Value Consultants.

The payout at maturity will be par of $10 plus triple any gain in the index, up to a maximum return of at least 10.8% that will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will be fully exposed to any decline in the index.

The index only needs to grow by 3.60% over the 13-month period, or 3.33% a year to enable investors to capture the maximum return, Vile said. Over the 13-month time, the annualized cap is 9.96% on a compounded basis.

Short duration

“You only need a very modest increase in the benchmark to get about 10% a year. But the downside offers no protection. Therefore this is a bullish investment otherwise some sort of buffer or barrier would be included. But you can’t be too bullish either since it takes only a slight rise in the index to get you to the cap,” he said.

One of the appeals of the product, he said, was its short duration.

“A 13-month term is pretty short compared to most leveraged notes.”

Giving up the protection for a short-term investment represents a valuable tradeoff for some investors.

“It’s easier to shorten the notes when there is full downside exposure,” he said.

The three-times leverage on the upside is asymetrical as most structured notes are, he said, pointing to the one-to-one downside exposure, an advantage for the noteholders compared to an outright investment in a levered index fund.

“If you had a three-time exposure to the index fund, you would get three-times on the upside but also three-times on the downside. There is definitely an advantage in the structured note. Your downside exposure is unlevered.”

And yet, the absence of any downside protection presents more risk than many leveraged products, he said.

“This is not a very defensive structure. There is a significant amount of leverage, which means that the issuer spent money buying call options. They could have raised the cap by decreasing the amount of leverage to two-times for instance instead of three. If you put less money in the call options you would have more to raise the cap.”

The key metrics of risk, returns and price are measured through various scores, which are established by Future Value Consultants. The research methodology generates reports designed to assess the quality of a product compared to its peers.

Return score

Future Value measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions – neutral assumption, bull and bear markets, and high and low volatility environments.

The return score is calculated based on the best among the five return scenarios, which for this particular product would be the bullish scenario.

At 6.93, the return score is below the 7.76 average, according to the report.

“It’s probably because of the cap and also the short duration. A year or slightly more than a year doesn’t give you a lot of time to compound the return.”

A number of similar products in this product type are uncapped and longer in term.

“It’s fair to say that without a cap or with a higher cap, the notes would have scored higher on the return scale.”

Risk assessed

Future Value Consultants assesses the risk associated with a product by adding two risk components – market risk and credit risk. The resulting riskmap measures risk on a scale of zero to 10 with 10 being the highest level of risk possible.

The market risk is “very average” at 2.69 versus 2.72 for the same product type, he noted.

Two factors were at play, he explained: First, the S&P 500 is not very volatile. Second, the structure offers no downside protection.

“You don’t get a lot of adverse movements from the index. But if it moves down, you immediately lose money.

“The two opposite factors balance out to average.

At 0.43, the credit risk is lower than the 0.56 average for the same product type, according to the report.

“This is short-term, you have less chance of having a credit event. The issuer’s creditworthiness is also quite good,” he said.

The five-year credit default swaps for JPMorgan are 64 basis points, according to Markit. The spreads are tighter than most other U.S. banks. Citigroup and Bank of America have CDS spreads of 73 and 72 bps, respectively. Morgan Stanley shows 85 bps and Goldman Sachs 89 bps.

Price score

For each product, Future Value computes a price score that measures the 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.

“It’s average. On one hand, you have a very liquid index constantly used for structured notes. So you see more competition, more transparency around pricing. That’s the positive part. But on the other hand, the short term pushes down the price score as we calculate on a fee-per-annum basis,” he said.

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The notes received a 7.17 overall score compared to 7.64 for the average for the same product type.

“We end up with a lower overall score, which is the direct result of the weak return rating. A higher cap would have helped,” he said.

The notes (Cusip: 48127P440) are expected to price on Jan. 2.

J.P. Morgan Securities LLC is the agent with Morgan Stanley Wealth Management as distributor.

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