JPMorgan’s $14.54 million autocallables linked to Apple offer high contingent coupon quickly

By Emma Trincal

New York, Aug. 31 – JPMorgan Chase & Co.’s $14.54 million of autocallable contingent interest notes due Sept. 14, 2016 linked to the common stock of Apple Inc. could offer an attractive alternative to owning the shares, but investors have to be ready for a very short-term investment, buysiders said.

Each quarter, the notes pay a contingent coupon at a rate of 20% per year if Apple shares close at or above the trigger level, 80% of the initial share price, on the review date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus the contingent coupon if Apple shares close at or above the initial share price on any review date other than the final review date.

The payout at maturity will be par plus the final contingent interest payment unless the final share price is less than the 80% trigger level, in which case investors will lose 1% for every 1% that the final share price is less than the initial share price.

Good alternative

“I actually like it,” said Carl Kunhardt, wealth adviser at Quest Capital Management, a buysider who typically prefers to invest in broad benchmarks than in single stocks.

“If you’re holding securities, you’ll have Apple. Twenty years ago, everybody had IBM, GE and Microsoft. Today, if you have a portfolio of U.S. equities, you’re going to hold Apple anyway.

“So the first question is, are you holding the stock? Then whether you’re going to hold Apple directly or through a note is a different conversation.”

Some structured notes are tied to underlying assets that offer high dividend yields, such as the Euro Stoxx 50 index with a 3.10% yield. Because structured notes investors do not receive dividends, the opportunity cost can be high with such underliers, especially for longer-dated notes.

“You’re not losing much on dividends with this note,” he said.

“It’s short-term. Apple doesn’t pay huge dividends. And you’re gathering 5% quarterly, which is hugely attractive.”

To own or not to own

Kunhardt conceded that the coupon is not guaranteed. However, he said that the odds of receiving it are high.

“In order not to get it, you’d have to see the stock drop 20%. It could happen, but you’re no worse off than if you held the stock long. In no way [do] the notes put me in a worse situation than if I was holding the stock long,” he said.

“As long as I’m going to hold the stock anyway, I don’t see any downside in using the notes as an alternative.

“In fact, I’m getting a lot of benefits from it.

“I get the 20% protection. You get a kicker payout of 5% per quarter. That’s incredibly attractive.

“Worst-case scenario, it gets called. I still collect my coupon, and that’s it.”

One of the key question Kunhardt said he likes to ask himself before investing in a note is whether holding the notes will give him an advantage over owning the underlying asset directly.

“In some cases, particularly with indices, I’m much better off being long the index or the fund.

“But in this case, I don’t see how the notes would put me in a worse scenario.

“OK there’s one: if Apple is up 40%, then yes. Apple is up 40%, and I only made half of it.

“But guess what? I can live with a 20% return. Pigs get fat. Hogs get slaughtered. I’ll take 20% anytime.”

Current price

Michael Kalscheur, financial adviser at Castle Wealth Advisors, objected to the autocallable feature that is the centerpiece of the structure.

“Normally I like an index, but if you’re going to have an individual stock, Apple is the most widely known in the country. So no problem here. And no issue having exposure to JPMorgan’s credit,” he said.

“But I’m not a big fan of autocallables in general. We haven’t done it. Not that autocalls are bad, but they are too short-term for our taste.”

With Apple’s recent decline, investors in the notes may have a good entry point, he noted.

“If Apple was close to its 52-week high, I would be a little bit more hesitant regarding the downside risk,” he said.

Apple shares dropped to a 52-week low last week during the Aug. 24 sell-off. Since then, the stock has gained 22.5%, closing at $112.76 on Monday. Yet it is still more than 16% below its 52-week high of April.

90-day deal

“Realistically, the stock is going to be up,” said Kalscheur.

And statistically, if the autocall is triggered, it will happen on the first call date, three months from now, he added.

“From the client’s standpoint, you buy the notes and you get your money back plus 5% in 90 days,” he said.

“You invest $1,000, you get 50 bucks. You put $10,000, you get $500.

“Nothing wrong with that. ... It would take you 10 years to get that return on a savings account or a CD.

“But your note is going to be a done deal after three months. It’s not a long-term holding. If it is, it means you have a problem with Apple. Or you may have a problem with the market. If there is another big shock, you could easily end up down by more than 20% at maturity. China just brought us down 10% in a couple of weeks. It could be something external that has nothing to do with the stock.”

Overall, Kalscheur was more concerned about the upside scenario – an autocall triggered on the first call date, leaving investors with a 5% gain rather than 20% – which he viewed as more likely to occur than the downside risk of breaching the barrier at maturity.

Time-consuming

“You’ll get called on the first call date,” he said.

“For us, it’s not ideal. We had to take the time to research the deal. Now three months later, we have to redo that homework,” he said.

“It’s very short-term-focused, and at the end of the day, nobody is going to retire on this particular offering.

“I don’t know anyone who is going to bet one million dollars that Apple is not going to go down 20% a year from now.

“It’s the largest company in the S&P. It’s not going out of business, but you’re still rolling the dice.

“When you collect your 5% coupon in three months, people are going to tell you it’s a 20% return. No it’s not. It’s just a 5% rate of return. The client is going to say, show me the other 15%! You probably have to move on to the next autocall.

“That means more research, more time spent on our end. I’m not even talking about fees. It’s an awful lot of hassle.

“We try to stay away from this. These types of products are designed for a high turnover. We don’t have the time and appetite to research these deals on a quarterly basis. Our shop isn’t built like that. I don’t care what underlying you’re using. ... It’s just not our style.”

The notes (Cusip: 48125US60) priced on Aug. 26.

J.P. Morgan Securities LLC was the agent.

The fee was 1%.

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