JPMorgan’s $1.56 million step-up autocalls on S&P Economic Cycle index show unusual terms

By Emma Trincal

New York, May 2 – JPMorgan Chase Financial Co. LLC’s $1.56 million of 0% step-up autocallable notes due April 30, 2025 linked to the S&P Economic Cycle Factor Rotator index combine call premium payout, uncapped participation in the upside at maturity and full downside protection in a little used underlying index.

The notes will be called at par plus an annualized call premium of 8.7% if the index closes at or above its call level on any annual review date other than the final date, according to a 424B2 with the Securities and Exchange Commission.

The call level will be 102.85% of the initial level on the first review date, stepping up by 285 basis points on each subsequent review date to a final level of 117.1% of the initial level on the sixth review date.

The payout at maturity will be par plus any index gain. If the index falls, the payout will be par.

Terms

“It’s appealing,” an industry source said.

“People get full principal-protection on an index that I assume is somewhat correlated to the S&P 500. You also get a compelling call coupon. The call level steps up but if you didn’t have that, you probably wouldn’t get full principal-protection and participation at maturity.”

The notes are designed for investors who are “happy” to see their notes called for nearly 9% a year, a market participant said.

“8.7% is not a bad return,” he said.

The coexistence in the structure of the autocallable feature, uncapped upside exposure and full downside protection against market risk intrigued this market participant.

“It’s a little bit unusual,” he said.

“The call option has to be very cheap for them to give you uncapped exposure.”

Memory premium

He noted the so-called “memory” feature, an aspect of the structure that income investors may find valuable.

“It’s not pure income, but at least you catch up with what you missed the year before,” he said.

He explained the memory premium with the following example:

If the notes are called on the second review date, investors will collect twice the 8.70% premium – one upon the call and the second payment to “catch up” with the premium they missed a year before during the previous call review. Overall investors receive a total 17.40% call premium when the notes get called after two years.

After six years, the call premium could generate a maximum return of 52.20%.

Pricing

This market participant was also interested in finding out how the issuer was able to price the full principal protection.

“You have to price a call option plus a zero-coupon, which is expensive. I imagine the index has a low volatility,” he said.

He was right.

The S&P Economic Cycle Factor Rotator index maintains a realized volatility cap at 6%, according to the prospectus.

The call strike stepping up was another solution to resolve the cost of the call options issue.

“The step up makes the whole thing cheaper as well. They’re cancelling the option and moving on to another one. Raising the strike each time helps with the economics of the deal,” he said.

Uncapped and capped

Investors should probably not expect to get full upside exposure at maturity, he noted.

“It’s probably better to get called. You want the index to go up, and then, you’re home free.”

Another reason to prefer the early redemption outcome is taxation.

“Those principal-protected notes are taxed like a bond. Even if you don’t get called, meaning you don’t get a fixed return, you have to pay income taxes. Each year you have to write a check to the IRS.”

“Your best outcome is to get out and get paid.”

The “uncapped” exposure at maturity was probably a very unlikely outcome, he also noted.

“You’re only uncapped at maturity. If the market goes up more than 2.85% a year they call you and you’re then capped. Your cap is the premium. It’s only uncapped if you don’t get called. And what’s the likelihood of this to happen over seven years?”

More about the index

The index tracks the return of a notional dynamic portfolio consisting the S&P 5-Year U.S. Treasury Note Futures Excess Return index as well as four excess price return U.S. equity indexes. The four equity indexes mimic strategies, which are low dividends, pure value, buybacks and momentum. The portfolio is rebalanced monthly to reflect an analysis of the stage of the U.S. business cycle.

The S&P Economic Cycle Factor Rotator index was developed by S&P Dow Jones Indices LLC and J.P. Morgan Securities LLC and is calculated, maintained and published by S&P Dow Jones Indices.

S&P Dow Jones has granted an exclusive license to JPMorgan.

JPMorgan just got started

Although the index was created in August 2016, JPMorgan has only begun to use it at the end of March in a $7.47 million offering deploying the same structure, according to data compiled by Prospect News, which tracks structured notes registered with the SEC.

Three other smaller deals have followed. They all priced on April 25 for a total of $2.36 million, including this one.

J.P. Morgan Securities LLC is the agent.

The notes are guaranteed by JPMorgan Chase & Co.

The Cusip is 48129MKJ4.

The fee is 4.12269%.

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