JPMorgan's $10.14 million knock-out notes tied to Bank of America offer high cap on risky bet

By Emma Trincal

New York, Jan. 12 - JPMorgan Chase & Co.'s $10.14 million of 0% capped daily observation knock-out notes due Jan. 25, 2012 linked to the common stock of Bank of America Corp. offer a generous cap with an attractive minimum contingent return, but the underlying volatility of the stock makes the product somewhat risky, sources said.

If the price of Bank of America stock falls by more than 31.8% from its initial price during the life of the notes, the payout at maturity will be par plus the stock return, which could be positive or negative, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, the payout will be par plus the greater of the stock return and 10%.

In either case, the payout will be subject to a maximum return of 25%.

For bulls

"The 25% cap is not bad at all. It's a pretty good deal if you're bullish on Bank of America," a sellsider said.

"But this is still a risky product, and you have to look at the fundamentals.

"I wonder why you would choose to get into this deal just before the earnings. It's a volatile stock, and breaching the 32% barrier in one year is entirely possible."

The bank will report its fourth-quarter financial results on Jan. 21.

Extreme scenarios

An analyst covering the stock said that there was potential for both losses and gains given the stock volatility. He said that the stock price could hit the 25% cap on the upside just as it may breach the 32% barrier on the downside.

"In the last 40 days, the stock has gone up by 36%. So I certainly think this stock could go up by more than 25% in 12 months," he said, adding that investors in such case may not maximize their potential return due to the cap.

Looking at the downside, he said that the stock last year dropped by 33% from its level at the beginning of the year. The decline almost reached 50% versus the high of 2010, he noted.

"Given the high historical volatility of Bank of America, I certainly wouldn't say that it's not possible for the stock to lose more than 32%," this analyst said.

The stock closed at $14.99 (NYSE: BAC) on Wednesday. It has a 52-week low of $10.91 and a 52-week high of $19.86. The share price is up 5.6% year-to-date.

Recovered sector

For bulls, Bank of America is one of the big winners in a financial sector that has largely recovered from its lows in 2008 during the worst of the financial crisis.

The Financial Select Sector SPDR exchange-traded fund as an example has gained 10% over the past 12 months.

"If you're optimistic about the financial industry, it's an attractive type of investment vehicle given the low interest rates," said Beth Kleiman, former managing director, exchange-traded products, at the New York Stock Exchange.

"After the tenuous environment of 2008, financial stocks have regained momentum, and a drop of one-third of the stock value seems like a lot," she said, talking about the knock-out buffer amount.

"If you agree that the perceived recovery of the financial industry has become a reality, it's a good deal."

J.P. Morgan Securities LLC is the agent.

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