JPMorgan’s dual directional barrier notes on S&P require strong call on range bound market

By Emma Trincal

New York, Jan. 19 – JPMorgan Chase Financial Co. LLC plans to price 0% capped dual directional contingent buffered notes due Feb. 7, 2018 linked to the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be guaranteed by JPMorgan Chase & Co.

If the index finishes above its initial level, the payout at maturity will be par plus the gain up to a maximum return of 6%.

If the index falls by up to the 16.5% contingent buffer, the payout will be par plus the absolute value of the return.

Otherwise, investors will be fully exposed to any losses.

Capped

“This is an interesting play but it would only work for someone who has a strong conviction that the market will be range bound in the next 12 months,” said Steve Doucette, financial adviser at Proctor Financial.

“You’re capped at 6% on the upside. You can outperform a little bit there but mostly if the market is flat.

“Obviously, you’re not bullish.

“On the downside you can significantly outperform the market. The index is down 16% and you’re up 16%. You outperform by 32%. That’s huge.”

Anyone’s guess

Wall Street strategists’ predictions last year have been revised upward since November. Doucette said that prior to the “Trump rally” most financial firms had called for muted or even flat returns in 2017.

If those calls still hold true, the notes could provide alpha in a slow-growth market, he said.

But at this point, he added, it is “very difficult” to predict the direction and range of future price moves.

“We had full exuberance in one month. A month in the market will never predict anything. If the flattish outlook we had still holds true, and I’d have to take a look, then you can outperform a lot on the upside. The market is flat and you make 6%,” he said.

“But consumer confidence is up, the economic indicators look good. We may have another run for another year, two years before the bear finally hits, in which case I miss potential upside because I’m capped at 6%.”

More on the downside

The downside offered more possibilities of excess return with its 16.50% scope of decline for absolute returns, but there was a risk. For one, the range of potential gains was greater below the initial price than above it.

But the wider range of return was commensurate with the downside risk.

Overall, the notes were designed to provide gains within a narrow window of index performance, he said.

“It’s easy for those absolute return notes to bust the barrier. I would be more concerned about breaching the barrier. Is 16.5% enough protection? That’s the main question.”

Conviction

The notes were “very interesting,” but their value depended on one’s view on the market cycle despite the non-directional nature of the payout. That’s because the benefits were skewed toward the downside, which offered nearly three times more potential return.

“If you don’t see any big run but flat returns or even some decline, this note is decent,” he said.

“But you have to make a prediction and have some conviction in your prediction: which way is it going and how far.”

Doucette said he preferred products that offered more balance with greater probabilities of winning.

“The market could be up more than 6% and it could also lose more than 16%. It’s too easy to bust through these ranges in this note,” he said.

“I’d look for something with more possibilities of outperforming in both directions no matter what the market does.

“I’d try to look for a basic buffered note. If the cap is reasonable at least you’re going to outperform.”

Upside risk

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he was not comfortable with the structure for similar reasons: the index could easily either rise above the 6% digital return or drop more than 16.5%.

“During the summer of last year this note would have looked interesting to me. Since then, the prospects for 2017 are improving just from an economic, specific GDP perspective,” he said.

“For that reason, I’m not sure I like the cap at 6%.”

Too short to call

The absolute return feature was attractive, he noted, but presented risks associated with the short maturity.

“I like the absolute return, but because it’s a short-term note, I would prefer a deeper barrier. If there is a pullback, it’s quite likely that it would be more than the existing barrier.

“It might be doable over a three- or four-year term. In that case having the absolute return and the point-to-point would make it very attractive.”

But for the next 12 months, the available protection appeared insufficient.

“We had such a strong bull market, so much price appreciation that it’s likely we’re going to get a pullback. We’re not sure if it’s going to be 12 months, two years or three years from now. But the odds of losing a lot of money are great if you hit the barrier and find yourself long the index on the downside.”

J.P. Morgan Securities LLC is the agent.

The notes will price on Friday.

The Cusip number is 46646QVF9.

© 2015 Prospect News.
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