JPMorgan prices digital notes offerings tied to Mexican peso to capture bullish peso bets

By Emma Trincal

New York, Nov. 21 - JPMorgan sold several digital notes tied to the Mexican peso in an effort to give investors access to what has become a popular currency strategy, albeit a risky one amid a looming fiscal cliff, sources said.

HSBC USA Inc. priced $10.78 million of 0% barrier notes due Dec. 3, 2013 with step-up digital return linked to the Mexican peso relative to the dollar, according to a 424B2 filing with the Securities and Exchange Commission.

If the currency return is more than 5%, the payout at maturity will be 23.45%.

If the currency gains by up to and including 5%, the payout will be 5%.

If the currency finishes at or above the 85% barrier level, the payout will be par.

Otherwise, investors will be fully exposed to losses.

Repeat deals

"It's not a bad structure, but the question is really the entry point," a currency analyst said.

"If we have a fiscal cliff, we could see the peso going down. It's a risk."

"Everybody is bullish on the peso right now. It's the place you want to be long-term, but short-term, you have to be prudent," he said.

A similar barrier note with step-up digital return also distributed by JPMorgan hit the market earlier this month. Goldman Sachs Group, Inc. priced $10.07 million of 0% currency-linked notes due Nov. 25, 2013 linked to the Mexican peso relative to the dollar. The terms were identical, including the barrier level, but the highest digital payout for any currency return above 5% was 22.10% instead of 23.45%.

A day earlier, Goldman Sachs issued nearly the same product in an $8.7 million offering of notes due Nov. 22, 2013. The only difference was the maximum digital payout of 22.9%.

Wedding cake

"It's called a wedding cake because of the different layers," a structurer said commenting on the three deals.

"If you have 5% on the move of the currency, you get X digital. If it's less, you get a smaller digital.

"The base of the cake, the largest one-- anywhere from flat to negative gives you no coupon but your principal based on not breaching the barrier," he said.

Digital payouts give investors a fixed return based on a particular percentage increase in the underlying price.

"It's a figure, not a formula. Some people like to know what they're going to get if their bet is right," he said.

Crowded trade

The offerings may correspond to an investment idea currently popular among investors who anticipate more U.S. growth looking forward.

"The peso is seen as a proxy on the U.S. economy," said the currency analyst.

"People are long the peso right now as they're betting on the recovery of the U.S. economy. They think that Mexico will benefit more from a U.S. recovery than the U.S.

"The idea is that the fiscal cliff will be avoided and we'll see some fiscal tightening but not enough to derail a U.S. recovery. Such outcome would be very good for the peso," he said.

In addition, the peso is popular because "it has good fundamentals" and is "a standard carry" trade, he noted.

If a note tied to the peso relative to the dollar can give investors a potential annualized return of 22.5% for just a 5% move in the Mexican currency, investors naturally have to incur risks, the currency analyst said.

"These trades are based on the bet that we won't have a fiscal cliff. I think it's the most probable scenario. But if we do, the dollar will surge in a flight to quality and the peso will collapse," he said.

"So I question the entry point on this trade. Everybody is already long the peso with very leveraged positions. You don't want to buy when everybody is buying," he said.

The HSBC offering (cusip: 40432X3L3) priced Nov. 16.

The two Goldman Sachs deals priced on Nov. 9 and Nov. 8.

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