New Trade JPM: In The Land of the Blind, The One Eyed Man is King

by Dan January 6, 2012 12:36 pm • Commentary

JPM has been widely regarded as the “best of breed” money-center bank throughout our financial crisis in 2008/09 and again since the bubbling up of the European Sovereign debt crisis mid last year.  At the same time, investors have shunned the banking group for the last 8 months, driving the stocks to valuation levels not seen since Q1 2009.    JPM has been spared certain indignities that its weaker peers like BAC and C have had to endure, but while the company has avoided certain pitfalls that others got associated with during the mortgage debacle, they face many of the same future challenges, which could make earnings visibility for 2012 in question.

Frankly there have been many reasons to be bearish on the sector, but of utmost concern by investors has been the increased regulatory scrutiny, and how new regulation dampens revenue and profit opportunities.  The business models for the banks/brokers have changed before our eyes in the last 2 years, and when you layer on choppy markets that have resulted in lower trading volumes and decreased deal activity the bull case looks challenged in the near term.

The Event:

The company will report Q4 earnings next Friday morning Jan 13th, the options market is expecting less than a 2% move, which is basically in line with the 4 qtr average.

Vols & Price Action:

At the money implied vol of about 40 looks fairly reasonable when you consider the 30, 60 and 90 day realized vol has been about 49.50, 53.50 and 55.50 respectively.

YTD JPM is up a little more than 6.5% which is dramatically outperforming Deutsche Bank which is down about 11.5% so far.   I have a sneaking suspicion that the violent price action this week in DB could be a little canary in the coal mine.

My Take:

As far as JPM is concerned, CEO Dimon will likely be upbeat about the company’s prospects in a constrained environment, but with the stock up about 25% since late Nov there appears to be a lot of good news in stock.

If you want to take a shot on the short side I think it makes a ton of sense to use options to define your risk, especially with volatility fairly cheap on a relative basis.

One Caveat: With the stock hovering around 35, at a key resistance level, any change in mood towards the space or some significant positive news relating to the European debt crisis, could have the stock complete this little double bottom phase the chart COULD be in.  Sentiment has been very bad in the space for a long time, and when it turns these stocks could go up for weeks, so you don’t want to be caught naked short these things……

1 Yr JPM chart from Bloomberg


But in my regular contrarian manner I would rather take a shot to fade the recent move into next weeks earnings.  I think this is a trade that you want to “wade into” over the course of the week, I put on half a position today and will look to add more next week.

TRADE: JPM $35.42 Bought Jan13th weekly 35/33 Put Spread for .45

-Bought 1 Jan13th weekly 35 Put for .60

-Sold 1 Jan13th weekly 33 Put at .15

Break_even On Jan13th weekly expiration (next Friday):

Profits btwn 34.55 and 33, make up to 1.55, max gain 33 or lower of 1.55

Losses btwn 34.55 and 35 of up to .45, with max loss of .45 at 35 or higher.