JPMorgan’s $550,000 bearish notes on S&P 500 pay absolute return in one direction

By Emma Trincal

New York, Sept. 2 – JPMorgan Chase Financial Co. LLC’s $550,000 of 0% bearish notes due Sept. 15, 2021 based on the S&P 500 index present a relatively new structure combining the benefits of absolute returns with a buffer based on a strictly bearish bias, sources said. This makes the product vastly different from the common dual-directional type of note.

If the index finishes at or above its initial level, the payout will be par, according to a 424B2 filed with the Securities and Exchange Commission.

If the index declines by up to 24%, the payout will be par plus the absolute value of the index return.

Otherwise, investors will lose 1.31579% for every 1% that the index declines beyond 24%.

“Interesting. It’s a bit different,” said an industry source.

“It’s a range. You have to have a very specific bearish view. As an adviser, you need to understand exactly what the client is trying to accomplish.”

Different

The notes are not dual directional as investors will not benefit from any upside.

They also differ from many bear structures, such as autocallable bear notes, which pay a call premium if the index falls below its initial level on any given observation date.

The product is also distinct from so-called “shark notes,” spotted last year, according to data compiled by Prospect News. Shark notes offer principal protection over a relatively short period of time. But getting paid the absolute return is made difficult because no payment will be made if the barrier ever breaches on any trading day during the life of the notes.

There may be reasons explaining the absence of those shark notes this year.

“They may be too tough to put together now. You can’t do full principal protection anymore with such low interest rates,” said a market participant.

The JPMorgan structure may have been designed to provide bearish exposure with some level of hard protection albeit not full protection.

Hedging tool

A registered investment adviser welcomed the product.

“I like it a lot,” he said.

“It’s a good way to hedge at a time when markets keep on hitting new record highs. You can always buy an inverse ETF but then, if the market goes up you lose money. Here, you don’t. That’s the part I like,” this adviser said.

The one-year length was also attractive for investors nervous about the short-term economic and political outlook.

“We’re heading into uncertain territory. The timing is good,” he said.

While investors won’t incur any loss if the index is up at maturity, principal is at risk on the downside.

“You can make a positive return with a decline of 24% or less. If the index goes down lower, you lose money. But you still have a buffer. Even though it’s a geared buffer., you’re still going to outperform on the downside. Market is down 30% you lose less than 8%.

“It’s a good way to protect your portfolio.”

Option legs

The trade can be explained with options, said the industry source.

“You’re long an at-the-money put, which knocks out at the 76 strike. To finance the option, you’re short a deep out-of-the money put at the 76 strike.”

The long at-the-money put protects against any losses from the initial price, but the option gets “knocked out” (dies) if the price declines beyond the 76% level, beyond the buffer. The sale of the “deep out of the money” put provides a premium, which will remain intact as long as the option remains “out of the money,” which means above the put strike. The term “deep” implies that the strike price is significantly lower than the current (or initial price).

Wide range of returns

Such difference corresponds to the range, which allows investors to profit from the trade, said a market participant.

“A 24% range is not bad. Most of our clients when you talk to them about a pullback expect a 10% to 15% decline. If that’s your view, you’ll be very well positioned with this note,” he said.

“If you’re misguided and the pullback drives the market down more than 24%, you still have the buffer and 24% is a pretty good buffer. Still, you’re taking the risk.”

Investors should consider the length of the trade in order to assess such risk, he added.

“Some people may not be comfortable with a one-year play. A lot of people would prefer three to four years. If the market plunges, like in February, there will be enough time to recover.”

Dual hurdles

Bear notes are usually small-size deals, this market participant said.

“These are tough products to sell,” he said.

“People may say they’re bearish, but it doesn’t mean anything. When they’re bearish, they don’t do anything and when they’re bullish, they invest. They generally don’t express their bearish views,” he said.

The structure itself has its limitations.

“One of the issues I have here is that you don’t make money if the market is up. Dual-directional products are more compelling. You make money, within a certain range...but you do make money if the market is up or down. Either way you do well,” he said.

“Here in order to win, you need to make sure the market won’t drop more than 24% and you also want to be sure it won’t go up.

“You’ve got to clear two hurdles –one is to guess the direction correctly and two, you’ve got to pick the right range.”

No leveraging

This market participant also argued that buying a put option would provide better protection if the goal is to hedge a portfolio.

“It’s a hedge but not such a great hedge,” he said.

“You still have to invest money in it. If you have to protect a $1 million portfolio, you have to buy $1 million worth of this note. It’s not like buying an option which will give you plenty of leverage. It’s not a full hedge.

“It’s also an imperfect hedge.

“Your protection disappears if the market is down more than 24%. So, I’m not sure hedging with this note is the most efficient strategy.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent

The notes priced on Friday and settled on Wednesday.

The Cusip number is 48132MF97.

The fee is 1%.

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