JPMorgan’s capped buffered leveraged notes tied to EM ETF offer bet on a modest recovery

By Emma Trincal

New York, Dec. 24 – JPMorgan Chase Financial Co. LLC’s 0% capped buffered return enhanced notes due Dec. 31, 2021 linked to the iShares MSCI Emerging Markets exchange-traded fund are designed for investors hoping to benefit from a rebound in emerging markets but ruling out an aggressively bullish scenario, sources said.

If the final share price is greater than the initial share price, the payout at maturity will be par plus two times the ETF return, subject to a maximum return that is expected to be 22% to 25% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the ETF declines by 10% or less and will lose 1% for every 1% that it declines beyond 10%.

Catching up

“This is an interesting note. You can look at it in different ways,” said Clemens Kownatzki, independent currency and options trader.

“The concept behind this is there might be a catch-up play.

“Emerging markets have really lagged the S&P 500. The S&P is up 30% this year and the emerging markets, 17%.

“The mindset is unless there’s a massive escalation of this U.S.-China trade war, emerging markets will be able to catch up.

“It would be some kind of range bound recovery though because your upside is capped.”

Assuming a 24% cap set at pricing, the annualized compounded return would only be 11.35%. An increase of 5.85% a year would be enough to allow investors to reach the cap.

IMF forecast

Kownatzki pointed to recent bullish reports on emerging markets coming from the International Monetary Fund.

“They predict higher growth in emerging markets than in developed markets for 2020 and 2021,” he said.

The projected GDP for 2020 would be 1.6% for developed markets versus 4.60% for emerging markets. For 2021, the forecast is a growth of 1.7% and 4.8%, respectively.

“You have to take it with a grain of salt though... They make adjustments all the time,” he said.

“But if things are not escalating, I would expect a recovery in China and as a result, a recovery in lot of other emerging markets that supply China in minerals and materials like Brazil and Chile for instance.

“If the recovery is strong, the note might not give you enough return. You would get 11%, and if emerging markets do 17% as they did this year, you would have been better off with the ETF.”

But from an asset allocation, the notes still made sense.

“The U.S. is going to slow down. From that perspective, you could be invested in the notes to get a defensive exposure to emerging markets and still outperform the U.S.,” he said.

Pricey puts

Kownatzki said he liked having the 10% buffer. But he would try to replicate the protection himself to lower the cost. Unfortunately buying a put option was not cheap.

“If I buy an out-of-the-money put right now at 90, it would cost me 7.5%. It’s a huge expense,” he said.

Buying an out-of-the money put at 90 means that investors would be protected against any price decline below 90% of initial price. The 90% strike price is out-of-the-money because the current price is above it. If the price declined below 90, investors long a put would have the right to sell the underlying at 90, which would protect them from any further decline, just as they would be protected with a 10% buffer.

“I would still want to buy the put but I would wait to see if the market remains steady for a while before doing that. It would be cheaper. I would also be buying some time. By waiting longer, I wouldn’t have to pay all that time value, so my put would be less expensive than if I was buying it today,” he said.

Buffer

Tom Balcom, founder of 1650 Wealth Management, said he would have preferred to see more protection.

“The question here is your downside risk. You have exposure to emerging markets, a pretty volatile asset class. I can’t get too excited over a 10% buffer on a two-year,” he said.

“Obviously the note is designed to give you a little more upside. 11% a year is not too shabby. You can easily outperform the ETF if it doesn’t go up that much.

“But what if it does? If the trade conflict is resolved you can expect emerging markets to skyrocket and then you’d be capped.

“It really depends on your outlook. If you envision a modest growth scenario, then it might be a good play. If you see a moderate pullback, that’s good too. The ETF is down 20% you’re only down 10%. That’s OK.

“But personally, if I buy a note rather than an ETF it’s to create a defensive position.

“We usually get 20% buffer on a two-year note. 10% isn’t going to do it for us.”

The notes will be guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will settle on Jan. 2.

The Cusip number is 48132HDU3.

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