JPMorgan's capped barrier notes linked to Apple may compete with a long position in the stock

By Emma Trincal

New York, April 1 - JPMorgan Chase & Co.'s 0% capped contingent buffered return enhanced notes due April 16, 2015 linked to the common stock of Apple Inc. are appealing to Apple fans, but the question remains whether it's worth it for investors to buy the notes instead of owning the shares directly, sources said.

For investors cautious about downside risk, the notes may offer an alternative to a direct participation in the stock, they said.

If the final share price is greater than the initial share price, the payout at maturity will be par plus double the stock return, subject to a maximum return of 45% to 55%. The exact cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the final share price is less than the initial share price by up to 20%, the payout will be par.

If the final share price is less than the initial share price by more than 20%, investors will lose 1% for every 1% that the final share price is less than the initial share price.

Single-stock bet

Carl Kunhardt, wealth adviser at Quest Capital Management, said that he would not buy the notes for his clients but may consider the product for himself.

"I like it," he said.

"Unfortunately, it wouldn't fit in my clients' portfolios because I don't use notes tied to single stocks in general. But I may consider it for my own portfolio."

Kunhardt said that he avoids single-stock-linked notes because the bet on one security is too risky compared to getting exposure to an index. But in this case, he may consider the notes for himself due to his bullish view on Apple.

"I'm a big believer in Apple. Yes, we may have a lot of tablets from different manufacturers, but they don't have the apps universe to compete with Apple.

"Other people will be competing with cheaper products, and precisely, that's what those products are: cheaper, not better.

"The reason why Android makes less expensive products is because Google gives the operating system for free.

"You get what you pay for. The problem with having such an open architecture is that everybody writes apps on it.

"Apple on the other hand wants to have total control over their operating universe, and the result is that they have much better apps.

"Apple does everything much better than everybody else. They have a knack for creating something that nobody knows they even want yet.

"Everybody is still playing catch-up with them. And that's when Apple comes up with something new that nobody thought of. The stock has been hit, but people underestimate Apple. I don't. I'm an Apple fan."

Kunhardt said that he was comfortable with the 20% contingent protection from downside risk.

"The barrier is reasonable. I'm still an Apple fan," he said.

He added that he understood that investors have to pay for the protection.

"I don't like caps, and I don't like leverage," he said.

"But you have a 20% barrier. I understand why you have the cap and the leverage. You have to live with it."

An exception

Michael Kalscheur, financial adviser with Castle Wealth Advisors, said he was also bullish on the stock.

"Being a stockholder of Apple myself, I'm intrigued by this note just because it's Apple," he said.

"They have great products, a great reach, a very strong brand, and they're highly profitable. Everybody is trying to imitate the giant. But they're still the industry leader. The company is going to be there for a long time."

Kalscheur said that the product may represent an exception to the few rules he usually follows when investing in structured notes on the behalf of his clients.

"Normally, I'm hesitant to consider single stocks or even small indexes because you're really betting on just one name. But Apple is not your average stock. This would be an exception because the stock is so widely held, everybody knows what it is and most people have a portion of their portfolio in Apple either directly or through QQQ," he said.

He was referring to the PowerShares QQQ, an exchange-traded fund based on the Nasdaq 100 index. Apple, the top holding in the fund, has a weighting of nearly 13%.

"Another general rule is that I don't really want caps. But then again, because it's Apple stock, I would perhaps make an exception because it's so huge. I don't imagine the stock doubling in value in the next two years," he said.

"It's right now trading at $430 a share. I doubt that it could be up to $1,000 in two years. I'd have a hard time buying this idea unless the whole market was up.

"It would be different if you had a very small aggressive company that could double in two years. In that case, you certainly wouldn't want a cap.

"So yes, I tend to stay away from caps. But because it's Apple, maybe I would make an exception in this case."

Kalscheur said that he liked JPMorgan's credit. "JPMorgan is good," he said.

The 2.5% fee, on the other hand, was a "little pricey," he said. "I'm not too excited about the fee structure."

But the limited protection - the barrier ceases to protect once breached - was Kalscheur's main concern.

Barrier limitation

"The nature of these barriers is a problem for me," he said.

"If it was a 20% hard protection or even 10%, it would be very different.

"But here, best-case scenario I have a limited upside; worst-case scenario, I have all the downside risk. I'm already nervous about the market as it is.

"I could buy the stock and have all the upside potential. If I was long the stock, I would have the dividends; I wouldn't have the fee. I may not have the downside protection, but I would have the liquidity. I would hate to tie up my money for two years on this."

Given the high price of the shares - Apple closed at $429 on Monday - one advantage of the notes, he said, was to allow investors to "roll the dice with Apple" at a lower level of risk.

"But if I wanted a small bite of Apple, I would prefer to get the exposure through the QQQ ETF. That way, I would get more diversification. I would also get exposure to Google.

"Most bulls on Apple choose to simply buy the stock," he said.

Kalscheur said that he could "live with the cap" because Apple may not surge in price due to its size. Yet, he still saw considerable upside risk in the notes. Depending on how much the stock price may exceed the cap, he would try to convince the issuer to buy back the notes.

"Imagine the stock is up 50% to $650. If I'm in the notes, I would be capped. It's a two-year product. What would be my options? I'm already capped out. I have no upside potential," he said.

"The only solution would be to speak with the issuer and ask them if they would be willing to call the notes back.

"I've talked to issuers in the past. Deutsche Bank has offered to do this. You'd have to know who you're working with. When you look at the prospectus, you routinely read that the notes are not listed on any exchange, that the issuer may offer to purchase the notes but is not required to do so."

To conclude, Kalscheur said that he wouldn't use the notes simply because of the barrier.

"It's not so much the cap. It's the barrier," he said.

"I'm a downside-protection-kind of guy. If I see some notes where the buffer is not there, where it's just a barrier, I think I would take a pass on them.

"But my advice to someone who may consider those notes would be to go to JP Morgan and ask them very detailed questions on the early redemption opportunities if the stock performance exceeds the top end."

The notes (Cusip: 48126DK24) are expected to price April 12 and settle April 17.

J.P. Morgan Securities LLC is the agent.

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