JPMorgan’s 10.25% contingent interest autocall notes on two stocks look attractive, source says

By Emma Trincal

New York, Aug. 13 – JPMorgan Chase Financial Co. LLC’s autocallable contingent interest notes due Aug. 19, 2021 linked to the lesser performing of the American Depositary Shares of Alibaba Group Holding Ltd. and the common stock of Amazon.com, Inc. appear to give investors a margin of safety despite the volatility of the two underlying stocks, sources said.

The notes will pay a contingent quarterly coupon at an annual rate of 10.25% if each stock closes at or above its 60% coupon barrier on the review date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each stock closes at or above its initial level on any quarterly review date starting on Feb. 5, 2019.

The payout at maturity will be par unless either stock finishes below its 60% trigger level, in which case investors will be fully exposed to any losses of the worse performing stock.

Positive correlation

“These are two volatile stocks. But the 60% barrier offers a pretty good cushion,” an industry source said.

The two e-commerce giant companies have many things in common, he added.

“There is a consumer/technology/internet link between Amazon and Alibaba,” he said.

“They’re fairly correlated.”

He was referring to the charts of the two stocks showing comparable price action except in the past couple of months when Alibaba began to trade downward while Amazon was going up, hitting new highs at regular intervals.

Alibaba is 16% from its 52-week high, and Amazon is 1.5% away from it.

But aside from this recent trend, the risk of divergence is reduced, he said.

“It’s almost a single-stock play,” he said.

Call protection

The term of the notes could be a risk factor. But the structure reduced the odds of a negative outcome.

“Three years seems like a long time but you’ll probably get called in six months,” he said.

For income-seekers, having a six-month call protection on a note paying a quarterly contingent coupon was an advantage.

“It’s always better to be able to capture half of the annual coupon than being called at the end of the first quarter,” he said.

“This deal seems optically very attractive.”

Not a basket

Clemens Kownatzki, an independent currency and options trader, examined the risk-reward of the notes and said he found the product competitively priced.

“It’s an interesting structure, no question about it,” he said.

The correlation between the two stocks was positive and at times fairly high, he noted.

“From a risk standpoint a worst-of requires a fair amount of positive correlation. If it was a basket it would be the opposite,” he said.

“In a basket made of 50% Amazon and 50% Alibaba, you’d want diversification, certainly not correlation. But here, you’re exposed to the worst-of, you want them to behave similarly,” he explained.

After Alibaba went public in September 2014, the two stocks did not show much correlation, he said. But things changed later on. Since the IPO, the 110-day correlation has varied between 0.25 and 0.75.

“It’s hard to find stocks that are correlated above 0.80, so it’s actually not bad,” he said.

“These are two companies in the same sector pursuing a pretty aggressive growth strategy.”

Valuation, Chinese government

He examined both companies, analyzing their respective risks.

For Amazon, the valuation was an issue.

“Amazon is nearly at its all-time high. With a market capitalization of $925 billion it’s very close to the $1 trillion mark just hit by Apple. It has a very high P/E of 150, three times the P/E of Alibaba. They also have more debt...Amazon is much more leveraged,” he said.

But Amazon controls 50% of U.S. e-commerce, he added.

Alibaba on the other hand was exposed to geopolitical risk.

“As long as they are in the favor of the Chinese government they’re going to be protected. But if they lose the support of the government, they will be annihilated.

“Even though Alibaba is not near its high like Amazon, I see it having a greater risk of being down 40% in that timeframe given the political risk and the uncertainty of the country in which they operate,” he said.

Deaf market

On the macroeconomic level, Kownatzki noted how little impact rising geopolitical risks had on the market.

“The market continues to ignore all the bad news happening in the world, at least in the U.S.,” he said, citing the Turkish lira crisis and the trade restrictions and tariffs imposed by the U.S. to a number of countries, including China.

“Three years is hard to predict. But I don’t see a 40% drop in Amazon or even a 40% drop in Alibaba unless we have a major recession over the next three years,” he said.

Was it likely?

“I don’t think so,” he said.

“The economy is on a better footing now than it was a decade ago.

“Given that this market has a tendency to ignore major geopolitical events, I think the 40% barrier is quite safe.”

Short duration

Besides, investors are unlikely to be invested over the entire three-year period, he added.

“I think you go into that note on the view that you’ll get called in six months.

“The likelihood of a call in six months removes a lot of the risk. You’re no longer investing in a three-year note but in a much shorter product,” he said.

“I don’t see a 40% drop in the next six months. We’re more likely to see both stocks above par in six months.”

Kownatzki said the notes could appeal to investors seeking income.

“If I was an investor I would just seek out some protection on the public market. A put option would be expensive but I would only do that if I saw some risk popping out. I mean by that a new leadership or any change that would make me reconsider my original rationale behind my position.

“Overall, I think I like the notes.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will price on Aug. 15.

The Cusip number is 48130UBM6.

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