JPMorgan's $17.06 million enhanced notes on Oil Service Holdrs is repeat deal, new oil play

By Emma Trincal

New York, Jan. 27 - JPMorgan Chase & Co.'s sale of enhanced notes based on the Oil Service Holdrs trust confirms the popularity of a structure that has been used several times already this year, signaling that investors are looking for alternative plays on oil, sources said.

JPMorgan has already sold four similar deals so far this year, including this last one on Friday, totaling $74.48 million in less than one month, according to data compiled by Prospect News.

JPMorgan priced on Friday $17.06 million of 0% return enhanced notes due July 23, 2010 linked to the Oil Service Holdrs trust depositary receipts, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity is par plus triple any gain in the depositary receipt price, up to a maximum return of 17.46%. Investors will be exposed to any losses, losing 1% of par for every 1% decline in the underlying depositary receipts.

The Oil Service Holdrs trust is an investment vehicle that seeks to diversify investments in the oil service industry through a portfolio of 16 underlying stocks of companies involved in this sector. Although its depositary receipts are publicly traded, it is technically not an exchange-traded fund but a Holdr, which are generally grantor trusts.

The depositary receipts are up 3.5% year-to-date and has gained 55.5% over the past 12 months.

Repeat deal

Sources said that it is "intriguing" to see the frequency at which JPMorgan has been selling these leveraged notes either on its own behalf or for other issuers.

On Jan. 15, Credit Suisse, Nassau Branch priced $19.07 million of 0% return enhanced notes due July 21, 2010 linked to the Oil Service Holdrs trust. J.P. Morgan Securities Inc. and JPMorgan Chase Bank, NA were the agents.

The payout at maturity will be par plus triple any gain in the depositary receipts, up to a maximum return of 18%. Investors will be exposed to any losses.

On the same day, JPMorgan issued and sold $31.1 million of the same deal.

Finally on Friday, Credit Suisse priced $7.25 million of 0% return enhanced notes due July 23, 2010 featuring the same characteristics: three times leverage, the same underlying and a 17.46% cap.

Again, J.P. Morgan Securities and JPMorgan Chase Bank were the agents.

In addition, JPMorgan distributed the same deal last summer but with a higher cap of 27%. The issuer was HSBC USA Inc.

Play on oil

"It's a play on oil and a very popular one. JPMorgan has been selling it a lot. Maybe their trading is more aggressive so they get the best terms. They're also a very active distributor. It's not uncommon to see the same structure being distributed by the same agent for different guys," said a New York sellsider at another bank.

Deutsche Bank's attempt

Last month, Deutsche Bank AG, London Branch announced that it would price 0% enhanced participation notes due Dec. 23, 2011 linked to the same Oil Services Holdrs trust. Deutsche Bank Securities Inc. was supposed to be the agent.

While the leverage was only two times, the cap, to be set a pricing, was in a 52.6% to 61% range. The deal did not come to market.

"That's a cap that's too generous. Obviously if it was that high, my bet is that it was a mispricing. Even with less leverage, they could not do it," said the sellsider.

Sources said that part of the popularity of the JPMorgan deal, besides its attractive leverage, may also have to do with the underlying asset class, oil, and the choice of the Oil Services Holdrs.

"Oil is retail friendly. Agriculture is not well-known. It's mostly for professionals. When people want to play commodities, they usually go for gold or silver. This is a way to diversify away from metals," said the sellsider.

Different oil underlying

But the use of the Oil Service Holdrs is somewhat contrarian, as other ETFs are more visible and more popular, sources said.

"This ETF is not the largest one. The biggest oil ETF and by far the most well-known is the United States Oil fund, but it tracks the price of crude oil futures contracts," said Craig Pirrong, professor of finance and director of the Global Energy Management Institute for the Bauer College of Business at the University of Houston.

"Using an ETF linked to the commodity itself would be too expensive. So they do an ETF that tracks stock prices, preferably one of the most liquid to target oil," said the sellsider.

Feeding Exxon

Among the stocks that the trust holds, some, such as Schlumberger NV and Halliburton Co., have a large market capitalization, while others are smaller, said William Thatcher, financial adviser at Hammond Associates.

"These guys feed off the Exxon Mobil-types of companies; they're different from the big oil. They're linked to big oil but not directly. The more oil there is to drill, the more business they get. Maybe it's a market capitalization play," said Thatcher.

The market capitalization of Exxon Mobil Corp. is $311 billion. In comparison, Schlumberger's market capitalization is $78 billion and Halliburton, $27 billion.

No contango

Another advantage offered by this trust versus the more visible United States Oil fund, said Thatcher, is that it eliminates the contango risk associated with futures contract.

"The United States Oil fund is popular because retail brokers are uninformed customers," said Thatcher. "They see an oil ETF and they want to jump in. But in reality, it's really an ETF on futures. Futures prices are different from spot prices, and when you invest in an ETF like the [United States Oil fund], you are subject to contango. It's very possible that structurers may have picked the [Oil Service Holdrs] as a way to alleviate contango risk."

Contango describes a carrying charge market, where commodities futures destined for later delivery are priced higher than commodities delivered earlier. It creates an additional cost that may eat into the returns garnered by the appreciation in the price of the commodity.

Diversification

Matthew Bradbard, president of MB Wealth, a commodity brokerage in Fort Lauderdale, Fla., said, "The Oil Service Holdrs trust ETF is popular because it's a way to be diversified in energy in a bunch of different companies. So if three go down in price, the others can go up and you can still make money."

However, while bullish on oil, Bradbard said that he has no position in the Oil Service Holdrs because he "only trades futures and options" in the commodity space.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.