JPMorgan’s $25.77 million autocalls tied to Tesla show good timing, possible hedge for shorts

By Emma Trincal

New York, Sept. 12 – JPMorgan Chase Financial Co. LLC’s $25.77 million of contingent income autocallable securities due March 12, 2019 linked to Tesla, Inc. stock came at the right time for a big coupon, sources said.

The deal priced at the close of Friday after a controversial video showed the company’s chief executive officer Elon Musk smoking marijuana in a podcast.

The stock tumbled on that day, allowing JPMorgan to price the deal close to the shares’ lowest price this year.

The notes will pay a contingent monthly coupon at an annual rate of 24.5% if the stock closes at or above the 50% downside threshold on the determination date for that month, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if the stock closes at or above its initial level on any determination date other than the final date.

The payout at maturity will be par unless the stock finishes below its 50% downside threshold, in which case investors will lose 1% for each 1% decline.

Volatility spike

“Tesla took a big hit. A lot of negative news around Musk pushed volatility to higher levels,” said David Chojnacki, portfolio manager at Sabretooth Advisors.

The structure sells the volatility of the underlying stock, currently at 61.

The CBOE VIX index, which measures the implied volatility of S&P 500 index options, is, by comparison, just above 13. Even the most highly traded technology stocks tend to trend at volatility levels below 40.

Reputation risk

“They passed over a cigar made with marijuana. He took a hit on that and it raised a bunch of issues. If you run a company, you shouldn’t be doing that. You can’t do it especially if you’re running SpaceX, which is government-funded company,” a market participant said about Musk.

SpaceX is a privately held company that manufactures rockets and spacecraft. Musk is also its CEO.

“It showed a certain level of arrogance and immaturity that doesn’t bode well with shareholders.”

Funding secured tweet

But the selloff preceded the cigar.

What really got short-sellers in a frenzy happened early last month when Musk in a tweet said he was considering taking Tesla private, adding the key words “funding secured,” which prompted the Securities and Exchange Commission to investigate his comments.

At that time, the stock dropped 22% in less than a week from an intraday high of $390 to a low of $303.

When the notes priced on Friday, the stock had shed 7% on the day of the bizarre video, closing at $263 a share.

The structured products issuer was able to offer a price on the underlying shares discounted by nearly a third since its peak less than a month earlier.

Bargain-hunting

Despite his disappointment with the CEO’s behavior, the market participant agreed that the timing was right.

Since Friday, the stock has already regained 10%, closing on Wednesday at $290.54.

“Volatility is high and the share price tumbled. That gives you a very high coupon,” he said.

“It’s the buy at the dip mentality. Nothing wrong with that if you’re comfortable with the risk.

“I’m sure a number of advisers were.

“If you believe that nothing will happen to Tesla in the next six months, it’s a good deal.”

Notes versus stock

An adviser looked at the deal comparing it to a long position in the stock. He concluded that the product offered a sound alternative to a short-seller.

“This is an interesting deal. Obviously you sell the upside for a big coupon,” said Jonathan Tiemann, founder of Tiemann Investment Advisors.

“I like to compare notes with owning or selling the stock outright. In this case the comparison is more favorable if you’re short Tesla than long.”

Not for bulls

The disadvantage of buying the notes if one is bullish or mildly bullish is the limited upside, he explained.

“If you are a buyer of Tesla because you think the current drop is an aberration this may not be the way to go,” he said.

The likelihood of an early call, which is statistically verified for autocallable structures, would limit the amount of coupon to one month, he said.

“If the stock goes up, you get 2% for the first month and then you’re done.”

In the unlikely scenario of investors pocketing the entire coupon, the trade would still not be suitable for a bull.

“A very bullish investor who would buy the stock at those lows may expect more given the volatility and previous performance,” he said.

Last year Tesla shares gained 36%.

Smart hedge for shorts

“The interesting comparison is not being long the underlying. It’s being short the underlying,” he said.

“If you’re short and the stock goes up, you have full and unlimited upside risk. With this, you get your money back.

“It’s a lower-risk way of being short the stock. But the benefit flips if the stock goes down by more than half in six months, in which case you get creamed.”

A reasonably bearish investor however could benefit from the trade.

“Fifty percent is a big drop. If you don’t see that happening, your hedge against a rally is better with this rather than being short the stock,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The fee is 1.25%.

The Cusip is 48130V772.

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