JPMorgan’s $500,000 buffered digital notes on indexes boost protection but instill complexity

By Emma Trincal

New York, Feb. 16 – JPMorgan Chase Financial Co. LLC’s $500,000 of 0% buffered digital notes due March 13, 2023 linked to the lesser performing of the S&P 500 index and the Russell 2000 index present an unusual payout structure on the downside cumulating the benefits of a buffer with an “in-the-money” digital barrier.

If the least performing index is greater than or equal to the digital barrier, 90% of its initial index level, the payout at maturity will be par plus 6%, according to a 424B2 filing with the Securities and Exchange Commission.

If the least performing index is less than the digital barrier but not less by more than the 13.2% buffer amount, investors will receive par.

If the least performing index is less than the digital barrier by more than the 13.2% buffer, investors will lose 1% for every 1% that the least performing index declines beyond the 13.2% buffer.

“It’s an in-the-money digital note that gives you a little bit more of downside protection,” a market participant said.

In-the-money digital

The term “in-the-money” simply indicates that the initial price is above the digital barrier or strike price for the embedded call option. Most digital payouts are “in-the-money,” meaning investors get the premium if the underlying finishes at or above initial price.

“You’re going to outperform from -10% to +6%, which is a high likelihood scenario over a 13-month period,” he said.

“If you look at the bell curve, the highest probability is that it will fall into the center even if it’s a narrow range.”

A bell curve is a plot of normal distribution of probabilities. Its shape reveals that the highest distribution is at the center of the curve.

Slicing the downside

In-the-money digital notes are fairly common. What distinguishes the product from its peers is the double strike on the downside, one for the buffer at 87% of the initial level, the other for the digital barrier at 90%, he noted.

He rounded down the 13.2% buffer amount to 13% for clarification.

“It’s a little bit circumvoluted. Normally you get par back if the index is negative but still above the buffer. That would be anywhere between 100% and 87%. Here you have the digital above 90% and the buffer that kicks in below 87%. In between there’s this narrow range, three percentage points only, where you get your principal back.

“Very unusual,” he said.

Conservative, short play

“They put those three things apart. It does make it a little complex. But the whole idea was to create a very defensive structure. They built an extra protection from -13% to -10%. That’s not much. But it’s also a very short-term note. And you still get the in-the-money digital feature.”

A more intuitive pricing would have eliminated the two strikes making the buffer level coincide with the digital barrier, he said.

“But in that case, you’d have to give up something. If the digital can be triggered at -13% instead of -10%, that’s going to give you less than 6% in payout obviously.

“It’s interesting. They priced this deal trying to be heavily defensive. I haven’t seen that,” he said.

Tough sale

A buysider said he was not impressed with the notes.

“It’s weird. I find it overly complex. I wouldn’t show this to a client,” he said.

Another adviser agreed, saying that the intricacy of the downside would preclude him from recommending the notes.

“It seems like an interesting concept. I’ve not seen a note like that. But I wouldn’t do it,” he said.

“It’s too complicated. You don’t really know if you’re dealing with a barrier or a buffer. Too many outcomes. Too hard to break down.

“I’m sure it’s a neat investment strategy. But try to sell that concept when you have to explain it to a client in the real world. That’s not going to happen.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on Friday.

The Cusip number is 48133CN99.

The fee is 2.225%.

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