JPMorgan’s $7.22 million review notes on oil services ETF offer high return on volatile play

By Emma Trincal

New York, Feb. 13 – JPMorgan Chase Financial Co. LLC’s $7.22 million of 0% review notes due Feb. 10, 2027 linked to the VanEck Oil Services ETF show a mid-double-digit premium for a trade based on a volatile sector ETF, sources said. The magnitude of potential price moves was a concern. On the other hand, the step down associated with the call threshold and the cumulative nature of the premium were seen as favorable.

The notes will be called automatically at a premium of 14.75% per year if the ETF closes at or above its call level on any quarterly review date starting Aug. 5, 2024, according to a 424B2 filing with the Securities and Exchange Commission.

The call level is equal to 100% of initial level for the first three review dates, stepping down to 95% of the initial level for the fourth through seventh and to 90% for the eighth through final ones.

If the notes are not called and the ETF ends at or above its 60% downside threshold, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% that the ETF declines from initial level.

Likely call

“As an income play, it looks very attractive,” said Scott Cramer, president of Cramer & Rauchegger.

Cramer is bullish on the underlying. He pointed to the low price of the ETF.

“That sector has been beaten down,” he said.

The VanEck Oil Services ETF closed at $282.55 on the trade date, or 22.4% off its $364.08 multi-year high posted in mid-September.

“That note is going to be called. I’m not saying the fund cannot go down further. But I can’t imagine it wouldn’t be called at some point especially with the step down,” he said.

He was referring to the decreasing call threshold from 100% to 95% and from 95% to 90%.

“There’s a reason why the issuer is doing that. They need to protect themselves from the upside,” he said.

High spread

The autocall was a positive event. But its timing mattered too.

“I’m not thrilled by the step down. It increases the chances of getting called. But it is what it is,” he said.

On the plus side, the reinvestment risk was limited.

“In a declining rates environment, this yield will probably be even more attractive in a couple of years,” he said.

The notes feature a six-month no-call. If the notes get called on the first review date in August, investors will get a 7.37% payout.

“If you’re doing this for income, you’re getting a very good return, a very significant spread over the risk-free rate,” he said.

The three-year Treasury yields 4.45% giving investors in the note more than 10% in spread.

Strong sector

The barrier level, the low valuation of the ETF and Cramer’s outlook on energy made him comfortable with the risk involved.

“There’s a lot of downside protection,” he said.

“The world is going to be needing oil. We’re kind of short on oil. And the services industry is doing very well. All these oil services companies are making money.”

The top three holdings of the ETF are Schlumberger NV, now SLB, Halliburton Co. and Baker Hughes Co.

“I don’t see a lot of downside risk,” he said.

The premium of nearly 15% may also attract investors seeking growth.

“One could argue that it could even be used as equity replacement as long as you don’t expect the fund to rise more than 14%. If you’re very bullish on oil, of course, that’s not the right strategy.

“But I see it more as an income play,” he said.

Necessary call

Ken Nuttall, chief investment officer of BlackDiamond Wealth Management, said the best outcome for investors was the automatic call.

“If you think oil is going to be flattish, this would make sense. You’re hoping to get called in one year. That’s what you’re betting on,” he said.

The underlying (listed on the NYSE Arca under the ticker: “OIH”) was also “very unusual,” he noted.

“Normally people bet on energy with XLE, which is much larger than OIH,” he said.

XLE is the ticker for the Energy Select Sector SPDR ETF, which represents larger energy companies in the S&P 500 index. Some of the holdings such as the top two – Exxon Mobil Corp. and Chevron Corp. – are mega cap stocks.

The market capitalization of XLE is $35.6 billion versus $1.9 billion for OIH.

Another important difference, Nuttall noted, is the respective implied volatilities of each fund – 33.5% for OIH and 17.76% for XLE.

“You’re dealing with a very volatile ETF,” he said, which explains the nearly 15% annualized call premium.

Snowballs not rolling

Nuttall said he did not particularly like the “snowball” structure in general.

With a snowball, noteholders only get paid upon early redemption or at maturity providing that the call threshold condition is met. Traditional autocalls with contingent coupons on the other hand pay a coupon at barrier level, which can be earned throughout the life as long as the notes do not get called.

“What I don’t like so much about snowballs, and this includes this note, is that you don’t receive any coupon payment while holding the note. If you never get called, you could get stuck at maturity with nothing,” he said.

No gain at maturity would be the best downside scenario. If the underlying breaches the barrier, the losses of at least 40% of principal would be “painful.”

“Since you didn’t get any coupon, you can’t use them as a cushion to absorb some of your losses,” he added.

The step down was beneficial to investors as it increased the chances of a call. But OIH could easily drop below those 95% and 90% thresholds, he said.

Upside risk

The 60% barrier seemed deep at first glance but perhaps not for such a highly volatile underlying.

Volatility could play out both ways, he noted.

“Oil could move a lot up or down. You could see a huge return in the underlying price and you’re only getting 14.75%. It’s a missed opportunity,” he said.

A recent example was in 2022 when OIH’s share price jumped 66.25%.

“I really prefer getting paid along the way.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on Feb. 8.

The Cusip number is 48134TJ70.

The fee is 2%.

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