JPMorgan’s absolute return bearish notes offer ‘cost-efficient,’ partial hedge, advisers say

By Emma Trincal

New York, July 25 – JPMorgan priced several bearish notes providing full principal protection on the upside and absolute return on the downside within the range of a geared buffer. Two notes were linked to the Nasdaq-100 index while two others referenced the Euro Stoxx 50 index. For each index, the tenor was either a one-year or a 14-month.

One adviser examined the one-year Euro Stoxx 50-linked offering.

JPMorgan Chase Financial Co. LLC priced $2 million of 0% Bearish Buffered Absolute Return Notes due Aug. 23, 2023 based on the Euro Stoxx 50 index, according to a 424B2 filed with the Securities and Exchange Commission.

If the index finishes at or above its initial level, the payout will be par.

If the index declines by up to 36.5%, the payout will be par plus the absolute value of the index return.

Otherwise, investors will lose 1.5748% for every 1% that the index declines below 36.5%.

The fee is 1.09%.

Cost

“This note is quite expensive if you combine the fee over one year and the loss of dividend on an index that pays a high dividend,” said Steve Foldes, wealth manager and founder at Evensky & Katz / Foldes Financial Wealth Management.

The dividend yield of the Euro Stoxx 50 is 3.5%.

“While I like the strong credit of JPMorgan, the cost is pretty high,” he said.

Partial hedge

At first glance, the notes looked like a “pure” hedge, but Foldes disputed this view.

“It’s a hedge but only to a degree. If we have a calamity situation, which I think is unlikely, but if that happens, the price could fall more than 36% and you would start losing money at an accelerated pace.

“Don’t get me wrong. You do have some downside protection with the geared buffer,” he said.

For instance, a 40% drop in the index price would generate a 5.5% loss.

But then the note is no longer a hedge, he noted.

“This is a hedge only if you’re not extremely bearish,” he said.

And Foldes said he did not hold that view.

Bullish on Europe

“A year from now, I think the market in Europe will be higher especially with the index already down this year,” he said.

The Euro Stoxx 50 index has fallen by 16.1% year to date.

“In one year, we should see a resolution in Ukraine. Italy is going through an economic crisis. But I doubt Italy would leave the euro zone. Europe does not want any of its members to leave the euro. In the past, with Greece and Portugal, Europeans have proven they can keep their countries in line.”

Foldes is not inclined to take bearish positions in general.

“I don’t have to bet against the market. Historically, the market always trends up,” he said.

Another drawback with the note was its effect on clients’ relationships.

“There’s no upside if the index is up. It’s bad if the index drops 36% or more. You only win within a band above the buffer. And it’s expensive.

“There is a lot of explaining to do and it’s uncomfortable,” he said.

Capitalizing on the structure

Carl Kunhardt, wealth advisor at Quest Capital Management, looked at the Nasdaq-100 version of the one-year note.

Its payout structure was identical to the Euro Stoxx deal, according to a separate 424B2 filed with the Securities and Exchange Commission.

The maturity date was Aug. 22, 2023 and the 38.35% buffer showed a 1.6221 multiple.

“I would do this note,” he said.

“I don’t typically like bearish bets. But I would take advantage of the parameters of this one,” he said.

Ruling out the worst

Kunhardt’s first assumption was that the chances of a decline beyond the buffer were remote.

“It’s a one-year. The shorter the better,” he said.

“More and more people believe that we are already in a recession or about to go in a recession. That’s my view too.

“So, it’s very possible that we would end the 12-month timeframe negative.”

One reason to remove the very bearish scenario of a decline below the buffer was the fact that the Nasdaq has already dropped 25% year to date, he said.

“For the note to lose money, the index overall would have to drop 63%. I don’t see that happening,” he said.

Since this adviser “discounted” this scenario, only two outcomes were possible: principal-protection if the index is positive and absolute return if it declines by less than 38%.

Cost-effective hedge

Kunhardt said he could use the notes as a hedge on a long position on the Invesco QQQ Trust. The Invesco QQQ is the ETF that tracks the performance of the Nasdaq-100 index.

“I could benefit from a move on the upside with some downside protection. And on the downside, it’s a wash. This of course assumes a very low probability of breaching the buffer level,” he said.

He offered an example.

“The Nasdaq is up 20%. I’m up 20% on my long QQQ position. I lose nothing from the notes since I have the principal-protection.

“Now the Nasdaq is down 20%. I lose 20% on QQQ but I make 20% with the notes. I’m even.”

The strategy however was not without risks.

“The only ‘gotcha is if I pass the buffer. I’m doubling my losses in that case.

“But I’m confident we’re not going to blow pass the buffer. That’s the entire game of that strategy.

“It’s a cost-effective way of hedging,” he said.

Other deals

J.P. Morgan Securities LLC is the agent for all issues.

All notes are guaranteed by JPMorgan Chase & Co.

The one-year notes on the Euro Stoxx 50 index (Cusip: 48133LSZ6) will settle on Tuesday.

The one-year notes on the Nasdaq-100 index (Cusip:48133LQH8) settled on Monday.

The fee is 1.08%.

JPMorgan also issued a pair of 14-month offerings.

One is a $2 million issue of 0% Bearish Buffered Absolute Return Notes due Oct. 23, 2023 on the Euro Stoxx 50. The notes (Cusip: 48133LTA0) will settle on Tuesday. The fee is 1.25%.

The other is a 1.5 million offering of 0% Bearish Buffered Absolute Return Notes due Aug. 22, 2023 based on the Nasdaq-100 index.

The notes (Cusip: 48133LQG0) settled on Monday. The fee is 1.25%.

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