JPMorgan's digital buffered notes linked to ruble, krone offer bet for dollar bears, oil bulls

By Emma Trincal

New York, June 7 - JPMorgan Chase & Co.'s upcoming 0% digital plus contingent buffered notes due June 21, 2012 linked to the performance of a basket of currencies relative to the dollar offer a "reasonable structure" for dollar bears betting on the appreciation of two high-yielding currencies, a currency strategist said.

The underlying basket includes equal weights of the Russian ruble and the Norwegian krone, according to an FWP filing with the Securities and Exchange Commission, and it will increase if the currencies appreciate relative to the dollar.

If the final basket level is greater than or equal to the initial basket level, the payout at maturity will be par plus the greater of the digital return and the basket return. The digital return is expected to be at least 8% and will be set at pricing. If the basket level declines by 10% or less, the payout will be par. If the basket level declines more than 10%, investors will be fully exposed to the basket decline from the initial level.

An oil bet

For Marc Chandler, global head of currency strategy at Brown Brothers Harriman, the bullish bet on those two currencies against the dollar is justified for anyone bullish on oil or the economy because both currencies are a proxy for oil prices.

And while a one-year term is deemed uncertain, the structure offsets part of the risk, he said, making the product "reasonable" for investors.

"You should be getting a nice yield on both the Russian ruble and the Norwegian krone because they're tied to the price of oil. If oil goes up, those currencies will go up," Chandler said.

He explained why the two currencies move in the same direction as oil prices.

"Russia is a big gas station. And the Norwegian krone, with Norway on the North Sea, is really more of a petrocurrency than a regular currency," he said.

Chandler gave an illustration of the positive carry offered by the difference in yields between the one-month Russian government bond and the one-month U.S. Treasury yield. The former is 300 basis points and the latter only 2 bps.

Chandler said that being bullish on the basket against the dollar "made sense" as long as "oil prices continue to go up" and "the economy doesn't slow down."

"I'd be bullish if oil continued to rise in price, but I'm not too sure," he said.

"OPEC is meeting [Wednesday], and they could very well announce the first increase in output in two years.

"Besides, if the economy is slowing, demand for oil will slow down.

"On a three- or six-month note, I can see that bet. But one year is a long time."

Protective structure

However, the notes offer a structure that alleviates the risk, Chandler noted, and makes the bet worthwhile.

"The 8% digital seems reasonable. You earn a high yield which is based on the carry," he said.

"The first 10% down, you're covered. So you're protected for an 18% decline, really.

"These terms seem favorable to the investor, and with that structure, it makes sense to go one year."

Upside appeal

Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management, said that investing in the deal required having experience with currencies.

"But I like the fact that currency moves have very little correlation with the stock market and offer some diversification," he said.

Wright also said that the terms of the notes were appealing to investors.

"I like the structure. You get at least an 8% rate of return as long as the basket doesn't finish lower. It just has to be flat."

He also said that the possibility of receiving the 8% contingent return at maturity even if the basket appreciated by less than 8% was a plus.

"I like the digital coupon. If your basket is up only 4%, you get 8%. That's nice."

Wright said that the 10% buffer was "fair" and consistent with other products he has seen in the market.

"What's more unusual is to have no cap when you have a buffer. And that's a great feature too," he said.

The notes (Cusip: 48125XUF1) are expected to price June 10 and settle June 15.

J.P. Morgan Securities LLC is the agent.

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