JP Morgan Structured Investments - What am I missing?

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m4hwEdisb
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JP Morgan Structured Investments - What am I missing?

Post by m4hwEdisb » Tue Sep 25, 2018 7:45 pm

Hello all! This is my first post, just wanted your opinion on this structured note being sold by JP Morgan. Here's the link to the product specifics: https://sp.jpmorgan.com/spweb/content/download/427115 / The underlying indices are the iShares MSCI EAFE ETF (EFA) and EURO STOXX 50 Index. The Contingent Buffer Amount is 50% (if index declines, you only lose money after it declines more than 50%). The Upside Leverage Factor is "at least 3.10" (if the index rises, you'll make 3.10x the percent increase in the index). Here are the details from the link above:

If the Final Value of each Underlying is greater than or equal to its Initial Value, your payment at maturity per $1,000 principal amount note will be calculated as follows: $1,000 + ($1,000 × Lesser Performing Index Return × Upside Leverage Factor)

If the Final Value of either Underlying is less than its Initial Value but the Final Value of each Underlying is greater than or equal to its Initial Value or less than its Initial Value by up to the Contingent Buffer Amount, you will receive the principal amount of the notes at maturity.

If the Final Value of either Underlying is less than its Initial Value by more than the Contingent Buffer Amount (50%), your payment at
maturity per $1,000 principal amount note will be calculated as follows: $1,000 + ($1,000 × Lesser Performing Underlying Return)


So what am I missing here? I understand that structured investments are always a bad idea, but this one just seems too good to be true! Here's my rough analysis:

- I won't be able to collect dividends on the index. (Current dividend yield of EFA is 3.05%)
- I'll be taking on credit risk of JP Morgan for 5yrs. (High quality 5yr corporate bond yield is about 3.5%)
- In order to replicate the hypothetical returns of the note using options, you could use a margin account to get 3.1 leverage then buy at the money puts (enough to cover the 3.1x leverage), and then sell puts (enough to cover 1x your principal) with a strike 50% less than the spot price.
- Using an options pricing calculator, I figure the net cost of the options would be about 7% of principal per year.
- Let's say you have the ability to borrow money cheaply (2% per year). Getting 3.1x leverage would cost about 4% per year.

Cost estimate: 7% (cost of options) + 4% (cost to get 3.1x leverage) = 11% (total percent of principal needed per year to replicate note's return profile)
Risks: 3.05% (not getting return on dividends with note) + 3.5% (credit risk of JP Morgan) = 6.55%

It's seems as though your getting a free 4.45% (11% - 6.55% = 4.45%) with this structured note. There's no cap on how much you can make, and there are no additional fees for buying the product. I have to be missing something. How can I replicate the note's payment at maturity profile for a better price than they're offering? I can't think of a way, and it's not even close! Thanks so much for reading this long post! I greatly appreciate your help!
Last edited by m4hwEdisb on Tue Sep 25, 2018 8:10 pm, edited 1 time in total.

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Re: JP Morgan Structured Investments - What am I missing?

Post by LadyGeek » Tue Sep 25, 2018 8:08 pm

Welcome!

The wiki has some background info: Structured products Note the big orange box at the top of the article.
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Re: JP Morgan Structured Investments - What am I missing?

Post by Beat The Street » Tue Sep 25, 2018 8:34 pm

Not all structured products are bad, but most Bogleheads will disagree with me on that. The product seems fine, but the biggest issue is the credit risk.
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Re: JP Morgan Structured Investments - What am I missing?

Post by grabiner » Tue Sep 25, 2018 8:36 pm

This particular structured note cannot be simulated well with standard options, because of the abrupt drop; you lose nothing if the market drops 49%, but 50% if the market drops 50%. And this is a very undesirable property for an investment, as it will give you no downside protection precisely when you need downside protection. Thus, even if it were fairly priced (which it likely isn't), it is a poor investment, as you do not want this pattern of gains and losses.

There is also the trick that you get a return based on the lower of two indexes, and the indexes are not comparable. If the Asian markets outperform the European markets, you get no benefit from the outperformance; if the Asian markets underperform, your return is reduced.
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Re: JP Morgan Structured Investments - What am I missing?

Post by Phineas J. Whoopee » Tue Sep 25, 2018 8:38 pm

If JP Morgan Chase could raise capital at a lower cost by issuing simple bonds they would. What's in it for them?
PJW

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Re: JP Morgan Structured Investments - What am I missing?

Post by m4hwEdisb » Tue Sep 25, 2018 8:41 pm

grabiner wrote:
Tue Sep 25, 2018 8:36 pm
This particular structured note cannot be simulated well with standard options, because of the abrupt drop; you lose nothing if the market drops 49%, but 50% if the market drops 50%. And this is a very undesirable property for an investment, as it will give you no downside protection precisely when you need downside protection. Thus, even if it were fairly priced (which it likely isn't), it is a poor investment, as you do not want this pattern of gains and losses.
Thanks for pointing out the abrupt drop aspect of it. I was somehow overlooking that! That would change my calculations. Although, I could just buy some put options with a strike at 50% of the current spot price to shore up this deficiency in the return profile.

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Re: JP Morgan Structured Investments - What am I missing?

Post by SelfEmployed123 » Tue Sep 25, 2018 8:46 pm

m4hwEdisb wrote:
Tue Sep 25, 2018 8:41 pm
grabiner wrote:
Tue Sep 25, 2018 8:36 pm
This particular structured note cannot be simulated well with standard options, because of the abrupt drop; you lose nothing if the market drops 49%, but 50% if the market drops 50%. And this is a very undesirable property for an investment, as it will give you no downside protection precisely when you need downside protection. Thus, even if it were fairly priced (which it likely isn't), it is a poor investment, as you do not want this pattern of gains and losses.
Thanks for pointing out the abrupt drop aspect of it. I was somehow overlooking that! That would change my calculations. Although, I could just buy some put options with a strike at 50% of the current spot price to shore up this deficiency in the return profile.
Thanks Lady Geek for posting the links to Larry Swedroe's articles. This investment is extremely complex and hard to understand. I could be wrong but it seems to me like a principal protection note. If so, this article by Larry Swedroe explains why it's a bad investment: https://www.cbsnews.com/news/bad-invest ... ion-notes/

OP: you state in your post that there is no cap on how much you can make, but it states in the fine print: If the Final Value of each Underlying is greater than or equal to its Initial Value, your payment at maturity per $1,000 principal amount note will be calculated as follows: $1,000 + ($1,000 × Lesser Performing Index Return × Upside Leverage Factor). By definition that means there is a limit to how much you can make. It defines that limit as whichever index has lower earnings multiplied by an upside leverage factor (whatever that is). The above article explains that investments like this limit the upside you can make, which is a huge limitation.

If you are thinking of making this investment, why not invest directly in the iShares MSCI EAFE ETF (EFA) and EURO STOXX 50 Index instead? You'd have part ownership of thousands of companies. You'd collect the dividends every year. Your gains would be taxed at the more favorable capital gains rate (if in a taxable account). You won't be limiting your upside. Whatever the market returns you would earn for yourself. Is giving that up really worth it to limit your downside? Why not just buy and hold the stock indexes for the long term?
Last edited by SelfEmployed123 on Tue Sep 25, 2018 8:48 pm, edited 1 time in total.
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Re: JP Morgan Structured Investments - What am I missing?

Post by grabiner » Tue Sep 25, 2018 8:48 pm

m4hwEdisb wrote:
Tue Sep 25, 2018 8:41 pm
grabiner wrote:
Tue Sep 25, 2018 8:36 pm
This particular structured note cannot be simulated well with standard options, because of the abrupt drop; you lose nothing if the market drops 49%, but 50% if the market drops 50%. And this is a very undesirable property for an investment, as it will give you no downside protection precisely when you need downside protection. Thus, even if it were fairly priced (which it likely isn't), it is a poor investment, as you do not want this pattern of gains and losses.
Thanks for pointing out the abrupt drop aspect of it. I was somehow overlooking that! That would change my calculations. Although, I could just buy some put options with a strike at 50% of the current spot price to shore up this deficiency in the return profile.
This wouldn't work well, for the same reason that you can't simulate this note with standardized options. If you buy a put at 50% of the current spot price, that limits your loss to 50% plus whatever you paid for the put. But you would still have a 50% loss if the market crashed.

If you buy a put at 75% of the current spot price, that limits your loss to 25% plus the price of the option, which would give you some downside protection; however, this put would be significantly more expensive.
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Re: JP Morgan Structured Investments - What am I missing?

Post by unclescrooge » Tue Sep 25, 2018 8:55 pm

Given the volatility of foreign markets, there is a possibility that either of these indicies could lose 50% in any given 5 year period.

This seems like a suckers bet.

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Re: JP Morgan Structured Investments - What am I missing?

Post by m4hwEdisb » Tue Sep 25, 2018 9:31 pm

grabiner wrote:
Tue Sep 25, 2018 8:48 pm
m4hwEdisb wrote:
Tue Sep 25, 2018 8:41 pm
grabiner wrote:
Tue Sep 25, 2018 8:36 pm
This particular structured note cannot be simulated well with standard options, because of the abrupt drop; you lose nothing if the market drops 49%, but 50% if the market drops 50%. And this is a very undesirable property for an investment, as it will give you no downside protection precisely when you need downside protection. Thus, even if it were fairly priced (which it likely isn't), it is a poor investment, as you do not want this pattern of gains and losses.
Thanks for pointing out the abrupt drop aspect of it. I was somehow overlooking that! That would change my calculations. Although, I could just buy some put options with a strike at 50% of the current spot price to shore up this deficiency in the return profile.
This wouldn't work well, for the same reason that you can't simulate this note with standardized options. If you buy a put at 50% of the current spot price, that limits your loss to 50% plus whatever you paid for the put. But you would still have a 50% loss if the market crashed.

If you buy a put at 75% of the current spot price, that limits your loss to 25% plus the price of the option, which would give you some downside protection; however, this put would be significantly more expensive.
Yes you're right! Can't believe I missed that! This makes much more sense now. Downside protection would be much more expensive than I was thinking. Thanks everyone for your help!

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Re: JP Morgan Structured Investments - What am I missing?

Post by CedarWaxWing » Tue Sep 25, 2018 9:42 pm

My simplistic outlook on such a product: If I don't understand the risks, or why it HAS to be structured in that fashion, I avoid it.

I do not know much about "structured investments"... but I do know if it is very complicated, as in much more than a rental house, or a mutual fund that I can look up and find out the facts of that product... I would not touch it with a ten foot pole.

I also know that, coming from Chase, this product will be over priced. Its being complicated makes it hard to prove that... and therefor hard to prove it is not, so assume it is over priced.

It is also complicated for a reason... and the complications are in the bank's favor, not yours.

There are far more sophisticated investors on this list than I, and they seem to all agree with the end conclusion.

Thanks for posting this example of a Chase investment that is rigged.

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Re: JP Morgan Structured Investments - What am I missing?

Post by Nate79 » Tue Sep 25, 2018 10:23 pm

Search structured investment or JP Morgan structured investment to get past threads on this topic.

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Re: JP Morgan Structured Investments - What am I missing?

Post by Startled Cat » Tue Sep 25, 2018 11:15 pm

m4hwEdisb wrote:
Tue Sep 25, 2018 7:45 pm
- I'll be taking on credit risk of JP Morgan for 5yrs. (High quality 5yr corporate bond yield is about 3.5%)
I think you're overcounting the credit risk because you should really only count the spread from a risk-free return, not the entire bond yield. But as pointed out elsewhere, there are other problems with this analysis.

One issue with these notes is that any gain is taxed as ordinary income rather than long-term capital gains (I believe). This can be a big deal.

Also consider illiquidity. I suspect it's difficult or impossible to liquidate the investment before the term is up, and if it's possible, it probably involves taking a haircut.

I actually don't think these are terrible investments. I could see myself buying a similar note under the right circumstances. However, it probably makes sense to limit it to a small portion of your portfolio due to the credit risk, bad tax character, and illiquidity. And then it probably wouldn't have a very big impact on your overall returns. Shifting one's asset allocation toward more stock might accomplish pretty much the same thing without the downsides.

But if you want more equity exposure and don't have a better way to get it, or the downside protection lets you sleep better at night, it could be a reasonable product.

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Re: JP Morgan Structured Investments - What am I missing?

Post by ThrustVectoring » Wed Sep 26, 2018 1:04 am

Startled Cat wrote:
Tue Sep 25, 2018 11:15 pm
But if you want more equity exposure and don't have a better way to get it, or the downside protection lets you sleep better at night, it could be a reasonable product.
S&P 500 index call options are a better way to get it. Two-month out at-the-money call option (290 strike, 11/16 expiry) currently act like roughly $16k worth of equity and cost under $600 to purchase. You get killed in flat markets, less than owning the underlying in declining markets, and make significant amounts of money in bull markets. If you limit your premium paid to only new money saved, your overall portfolio isn't going to be so volatile that it explodes: worst case, you're older and market declines have simply wiped out all the new money you put in.

But honestly, 100% equity is (or should be) enough.
Current portfolio: 60% VTI / 40% VXUS

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Re: JP Morgan Structured Investments - What am I missing?

Post by AlphaLess » Wed Sep 26, 2018 1:32 am

Conceptually, you are missing three things:
- in all three scenarios, your payout is the LESSER of the two indices,
- in up scenario (both up), you get 3.1 * the LESSER of the two returns,
- in the mixed scenario, you get nothing,
- in the BIG DOWN (EITHER ONE), you get to pay for the down.

More specifically, let's say each index can have:
- UP (higher than the initial value),
- down (lower than the initial value, but above the buffer amount),
- BIG DOWN (down by 50% or more).

You then have these scenarios:
- {UP,UP} -> up for you, but by the LESSER of the two
- {UP,down} - flat for you
- {UP,BIG DOWN} - BIG DOWN for you
- {down,UP} - flat for you
- {down,down} - flat for you
- {down,BIG DOWN} - BIG DOWN for you
- {BIG DOWN,UP} - BIG DOWN for you
- {BIG DOWN,down} - BIG DOWN for you
- {BIG DOWN, BIG DOWN} - BIG DOWN for you, and by the lesser of the two

From an option replication point of view, there is a correlation risk (as shown above), which JP Morgan derivatives geeks can price it.

In terms of the details of what you captured: I am not sure your calculations are correct. You probably got the first order things taken care of, but I doubt you got it exactly right.

The picture in the note shows that your downside has a CLIFF.
I.e., you are NOT losing 1% when index is down 51% (from 100 to 49).
Rather, you are losing 51%.

I would say that:
- JP Morgan is probably pricing this more or less right (with a juicy commission for them), AND
- this is a rather crappy investment. I would HATE to have a payoff like that. Absolutely HATE it.
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Re: JP Morgan Structured Investments - What am I missing?

Post by jminv » Wed Sep 26, 2018 2:21 am

Retail structured investments like this one tend to be targeted at people who are greedy (leveraged returns) but who are also risk averse (the downside protection element). Normally, you would expect a catch with a high return low risk investment and in this case the risk is surely there. There’s also often the ‘exclusive’ nature of the offering (you need to be worth their while). They make things people want to buy and have enough offerings for any taste and this one appealed to you for some reason.

What you’re missing is where JP Morgan’s people expect the underlying to do which is probably not what you want it to do. For example, in a recession, I would imagine that they expect the lesser underlying to fall by more than 50% rendering the downside protection more of a marketing tactic than real protection. Similar issues with the upside. The other issue is that you could replicate this yourself with options for less money than JP will sell it to you for. JP Morgan is getting rewarded handsomely for selling this and in the event they do decide to provide liquidity - buying it back at a substantial discount (win two ways).

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Re: JP Morgan Structured Investments - What am I missing?

Post by denovo » Wed Sep 26, 2018 2:26 am

From your link
As a finance subsidiary, JPMorgan Chase Financial Company LLC has no
independent operations and has limited assets.
They'll fold if it's not a good deal for them.
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Re: JP Morgan Structured Investments - What am I missing?

Post by Mr.BB » Wed Sep 26, 2018 5:34 am

I had an advisor try to sell me something similar with a flexible CD. Bottom line is something that complicated probably benefits them more then it benefits you.
I'm not sure how long that program been in existence but I know when a guy was trying to tell me about the flexible CD program that's only been around for a few years so all he can tell me was about a program that was started in a bull market not a bear market.
Last edited by Mr.BB on Wed Sep 26, 2018 6:57 am, edited 2 times in total.
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Re: JP Morgan Structured Investments - What am I missing?

Post by HueyLD » Wed Sep 26, 2018 6:36 am

It seems that season again for JPM to push its (highly profitable) structured products to unsuspected retail customers.

And brokers are more than eager to peddle the products because commission is very good for the sales people.

In the previous major stock market peak before the bubble burst, their structured notes were better than the current ones. The older generation at least allowed you to get your initial investment back. But the current version doesn't even have this floor. IMO, The product went from bad to toxic.

It is amazing that structured notes such as those promoted by JPM tend to pop up when the stock market is high. And I look at the eagerness to push such products as a sign that the stock market is overvalued.

I've known two elderly widows who were sold such products as they were totally clueless. At the tax time, they were required to pay taxes on phantom income while not having cash flow to pay the tax liability. Very sad!

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Re: JP Morgan Structured Investments - What am I missing?

Post by Valuethinker » Thu Sep 27, 2018 3:01 am

HueyLD wrote:
Wed Sep 26, 2018 6:36 am
It seems that season again for JPM to push its (highly profitable) structured products to unsuspected retail customers.

And brokers are more than eager to peddle the products because commission is very good for the sales people.

In the previous major stock market peak before the bubble burst, their structured notes were better than the current ones. The older generation at least allowed you to get your initial investment back. But the current version doesn't even have this floor. IMO, The product went from bad to toxic.
Once interest rates dropped to as low as they have done, the underlying zero coupon bond could not recover the principal. Most of the money in the product would have to be in the bond.

It is amazing that structured notes such as those promoted by JPM tend to pop up when the stock market is high. And I look at the eagerness to push such products as a sign that the stock market is overvalued.
I've known two elderly widows who were sold such products as they were totally clueless. At the tax time, they were required to pay taxes on phantom income while not having cash flow to pay the tax liability. Very sad!
It's awful what is allowed out there. In Canada, it turns out the bank's duty of care to you, the client, hangs on the difference between "adviser" and "advisor".

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Re: JP Morgan Structured Investments - What am I missing?

Post by nedsaid » Thu Sep 27, 2018 3:13 am

Valuethinker wrote:
Thu Sep 27, 2018 3:01 am


It's awful what is allowed out there. In Canada, it turns out the bank's duty of care to you, the client, hangs on the difference between "adviser" and "advisor".
Po-tay-to, po-tah-to, To-may-to, To-mah-to, Advisor, Adviser, let's call the whole thing off.
A fool and his money are good for business.

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