New Trade $JPM: Fading Breakout

by Dan June 19, 2015 11:40 am • Commentary

JP Morgan (JPM) had a tough week with the untimely death of their Vice Chairman Jimmy Lee, who by all accounts was a legend in his own time. The trade that I am going to detail has nothing to do with the news this week, and is very squarely focused on JPM’s recent price action, an upcoming catalyst and my belief that breakouts are to be faded until proven otherwise.

Shares of JPM have massively outperformed the S&P 500 (SPX), up 9% ytd vs the SPX up 3% and the XLF up 2.5%, of which JPM is the third largest component with an 8% weighting.

The stock’s 26% gains from the 2015 lows has been a work of art, with an increasingly steep uptrend that has included a breakout to new all time highs:

JPM 1yr chart from Bloomberg
JPM 1yr chart from Bloomberg

The stock has benefited from the thought that rising yields will benefit the company in the form of higher net interest margins on their deposits. But I wonder if the stock’s gains, coupled with the move up in Treasury yields already discounts a lot of the benefits for the balance of the year. That, combined with what can only be seen as a Dovish statement by the Fed this week, and it is my sense a higher yield environment is in the stock.

The next identifiable catalyst for JPM will be Q2 earnings and Q3 guidance confirmed for the morning of July 14th.  The stock is not generally a huge mover on earnings, but in the last year the stock has had two 3.5% one day moves following results.

Options prices are not particularly expensive, with 30 day at the money implied vol (blue below, the price of options) at 17% is near the 2014 lows, but it is important to note that the slow and steady incline of the stock has caused realized vol (white below, how much the stock has been moving)  to make new lows for 2015 (almost daily).  The spread between the two suggests options prices are fair. Not cheap, but not particularity expensive:

JPM 1yr chart of 30 day at the money IV vs Realized vol from Bloomberg
JPM 1yr chart of 30 day at the money IV vs Realized vol from Bloomberg

With an eye on earnings and the thought that the stock may discount good news, and my belief that fading single stock upside breakouts may be a good trading strategy until the broad market confirms this trend, I want to make a defined risk bearish bet that JPM pulls back to just above its recent breakout level.

Trade: JPM ($68.20) Buy July 67.50 / 62.50 Put Spread for $1

-Buy to open 1 July 67.50 put for 1.15

-Sell to open 1 July 62.50 put at .15

Break-Even on July Expiration:

Profits: between 66.50 and 62.50 make up to 4, with max gain of 4 below 62.50

Losses: up to $1 between 66.50 and 67.50 with max loss of $1 above 67.50

Rationale:  It would take an all out market melt-down for JPM to be in the low $60s in the coming weeks, but we are selling the 62.50 puts to merely offset some near term decay in the 67.50 calls.  In the coming weeks we may consider rolling up the short strike to further lessen the break-even.