JPMorgan’s $26.94 million trigger autocalls on two ETFs offer pure U.S. value play

By Emma Trincal

New York, Sept. 8 – JPMorgan Chase Financial Co. LLC’s $26.94 million of trigger autocallable contingent yield notes due Aug. 29, 2024 linked to the iShares Russell 2000 Value ETF and iShares S&P 500 Value ETF allow investors to bet on value stocks while using the differences between large-cap and small-cap to generate more premium.

Each quarter, the notes will pay a contingent coupon at the rate of 6% per year if each ETF closes at or above the coupon barrier, 72% of the initial level, on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par of $10 plus the contingent coupon if each ETF closes at or above the initial level on any quarterly observation date after six months.

If the notes are not called and the final level is greater than or equal to the downside threshold level, 72% of the initial level, the payout at maturity will be par plus the final coupon. Otherwise, investors will lose 1% for every 1% that the final level is less than the initial level of the worst performer.

Value-oriented

“Investors buying this note are taking a view that value will take off as the Fed looks to taper its bond purchases,” said a market participant.

Investors have switched from value to growth at different times depending on their expectations on the direction of future interest rates and inflation but also the spread of the Delta variant of Covid, which could negatively impact the recovery, he added.

“Value stocks are better positioned in a rising interest rates environment,” he said.

“Growth is on a tear. It’s been a yin and yang between value and growth over the past few months. More and more people believe that the tech rally is overdone.”

Most growth stocks in the United States are in technology. Value is often found in sectors that have suffered from the Covid-19 pandemic causing valuations to drop.

“The development of the Delta variant however is a big unknown. If we see the spread of Covid worsen in the fall, the gains seen in some of the value/cyclical stocks may be compromised,” he said.

This market participant said the note was relatively attractive.

“The 6% coupon on a 72% barrier is a sweet spot,” he said.

“I like the three-year with a six-month no-call. Three years in general is a nice intermediate term.”

Too correlated

But a structurer expressed a more critical view on the product.

He first pointed to the high correlation between the two underlying ETFs. The three-year coefficient of correlation between them is 0.934.

“You may have large-cap versus small-cap, but since they’re both U.S. value funds, the correlation remains high, which doesn’t add much value,” he said.

“If you want to play value, do S&P value with Japanese value or S&P value with whatever value. I can’t understand why U.S. investors keep on getting exposure to U.S. stocks.

“Those two underlying are so tightly correlated, it’s close to one. Why do a worst-of in this case?”

The 6% coupon was not very compelling, he said. The 72% barrier was “average” and could have been much deeper with more dispersion between the assets, he added.

Historical correlation

This structurer explained that the choice of underlying in a worst-of should consider not just current, but also historical correlation levels as well.

“You want to start with a correlation that’s not high versus its historical average in the expectation that both underlying assets will converge,” he said.

Dispersion is easier to obtain when “the market is doing well,” he added.

“When the market goes south, everyone sells everything irrationally and correlations tend to spike. It’s when the market is up that they start to diverge.

“So, in the current market with the low volatility and low correlation between assets, you should strive for low correlations in your worst-of. That’s how you can extract value.”

By “value” he meant better terms in the form of a higher coupon and/or lower barrier.

Volatility and yields

In addition, investors give up dividends over the three-year period, he noted.

The iShares Russell 2000 Value ETF has a dividend yield of 1.23%. The yield on the iShares S&P 500 Value ETF is 1.86%.

“These are not very rich dividends, but they compound over three years. Again, I wouldn’t have chosen two underlying that are moving so closely together,” he said.

The bull market is not conducive to the pricing of high coupon rates, he noted.

“We don’t do index products anymore because volatility is too low,” he said.

“Most clients prefer stock picking right now.

“When a stock drops, volatility rises, and you can get better terms.

“I wouldn’t use indices unless the VIX moved above 25.”

The VIX index, which measures the volatility of S&P 500 index options, has not been at that level since mid-July. Its current level is slightly below 18.

The use of the two underlying (iShares Russell 2000 Value ETF and iShares S&P 500 Value ETF) in a worst-of has only been done in three other deals this year for a total of $4 million. JPMorgan Chase Financial was the issuer on all three, according to data compiled by Prospect News.

Another $40 million in 13 deals has been priced on the two matching indexes. Barclays Bank plc priced the largest one in March for $23 million.

The notes are guaranteed by JPMorgan Chase & Co.

UBS Financial Services Inc. and J.P. Morgan Securities LLC are the agents.

The notes (Cusip: 48132X594) settled on Aug. 30.

The fee is 2%.

© 2015 Prospect News.
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