UPDATE: JPM: Reports Q1 Earnings Apr 13 – Apr Put Flies Look Cheap

by Dan April 14, 2011 7:46 am • Commentary

UPDATE April 14, 2011: JPM reported Q1 results yesterday morning and while wall street analysts generally seemed pleased (most raising numbers and price targets on the back of strong investment banking results and decent trading), the stock’s general indifference, down almost 1% put a halt on the markets inexorable rise. Here a are a few excerpts from some analysts following the earnings call.

From Goldman Sachs Apr 13, 2011:

-JPM reported results that were ahead of expectations driven by better than- expected capital markets (FICC +82% qoq, equities +25%), a lower provision ($2.6 bn release) and reduced litigation costs ($400 mn; down $1.1 bn linked quarter), somewhat offset by elevated foreclosure expenses ($650 mn).

-Taken together, operating results were strong and core PPOP increased 17% linked quarter on our estimates. Shares declined today as loan growth was seasonally weak (-1%, although +0.30% ex. card) and increased servicing costs led to a $1.1 bn write-down of the MSR. Despite this, positive signs of loan demand are emerging as C&I utilization ticked up in the quarter and card balances are expected to begin to stabilize (given the seasonality trends).
-We reiterate our CL-Buy as we continue to believe the market is under-appreciating the $6+ of earnings power the franchise is capable of. With its shares trading at less than 9X its core run rate of about $4.80, we continue to believe there is significant upside potential.

From Citi Apr 13, 2011:

Reiterate Buy as JPM “Story” Remains Intact — While JPM shares sold off by 0.8% today (vs -1.1% for BKX) and we heard considerable skepticism from investors regarding the pace of buybacks, weak revenues and n/t expense bloat – we believe the core investment thesis for JPM remains intact. We were not discouraged by Dimon’s comments on repurchase price sensitivity given 1) we view it as a reiteration of what was previously said at the Feb investor day, and 2) we do not see any incentive to “talking up” buybacks. We expect buybacks this year to be on the high-end of the range of $3-8 billion (we factor in $7 billion of buybacks in 2011). With JPM trading at ~7x normalized EPS of $6.50 (which we believe could happen by 2013), we continue to see considerable value here especially, considering the company is currently operating at what we see as a high level of investment spending with a balance sheet bolstered by significant excess capital.

IN A NUT-SHELL, the strong results were driven by investment banking, cost controls and release of loan reserves that helped off-set weakness in the commercial bank, specifically continued losses on bad mortgages and home equity loans,  and the acknowledgement that mortgage origination’s have dropped 29% quarter over quarter.

SO WHAT TO DO WITH THAT JPM APR 46/44/42 Put Butterfly??? AT this point with the stock a little above 46 and 2 full trading days to expiration, the Apr 46 Put you own is very much in play and depending apon your market thesis for the balance of the week, this thing might be exactly where you want it. (I think you all know my thesis: PAIN)

-If JPM and the market for that matter, couldn’t rally on what appeared to be very good results from JPM, than I think it is safe to assume that BAC Q1 report due tomorrow morning won’t be of further assistance.  JPM is considered best of breed and while on surface results looked good investors seemed a bit more uneasy than wall street analysts who as a function of their own survival don’t make a sport of routinely trashing their close competitors.  Of the 35 analysts that cover JPM 30 have Buys and only 5 have holds and NO sell ratings.  The five Holds are all by small independent research firms (that you have likely never heard of, and even Meredith Whitney has a BUY on the stock.

-Treat the APR 46 put as you would any at the money option close to expiration, but look to close out at some point before, or on Friday before the close if it is in the money.  For instance I paid .18 for this Fly and as of yesterdays close it was trading higher than that.  If at some point if the stock were say 45 between now and friday’s close you could sell the 46 put for 1.oo or a bit more and then cover the two 44s for pennies and just move on.

-I am waiting for BAC’s earnings report before I do anything with this trade, as I think the potential for a messy report could serve as a catalyst to the downside for the financial sector.  But if I am wrong on direction and you want to try to recoup some of the premium you will have to move your feet, as I have said in the past, structures like FLYs can resemble the Hotel California, “You can checkout any time you like, But you can never leave!”   The multiple legs, bid/asks and commission can make it cost prohibitive to close.   So in this instance, when I paid .18 for this I was resigned to the fact that if I were wrong on direction, which I still may be, than I may not have the opportunity to get out for anything……

From April 7th 2011:

EVENT: JPM reports Q1 earnings on Apr 13 before the open, options market currently implying about a 3.25% move vs avg over the last 4 qtrs of ~2%.  So in some ways the move looks priced fairly rich….that said I am looking to litter my book with some low premium bearish bets that have near term catalysts…..

-I think the market is at top end of the range and we are due for a few % pull back, so earnings season kicking off next week could be just the catalyst to get things moving again….

TRADE: JPM (stock ref 47.45) Buy the APR 46 / 44 / 42 Put Fly for ~.18

-Buy 1 Apr 46 put for .34

-Sell 2 Apr 44 Puts at .10 (total of .20 credit)

-Buy 1 Apr 42 Put for .04

Break-evens on Apr Expiration: Simply Put  [46 lose .18, 44 make 1.82, 42 lose .18]

Upside: stock btwn 46 and 45.82 lose up to .18, stock above 46 you lose all .18.

Downside: Stock btwn 45.82 and 44 you can make up to 1.82…..

Best Case: stock 44 (down ~7% )you make 1.82.  bwtn 44 and 42 pay off trails off,

Worst Case: below 42 you lose .18 premium you paid.

TRADE RATIONALE: Savvy Trader rule of thumb on Flies: Look for at least 7 to 1 payout, this one is approx 11 to 1, I like the risk reward here.