JPM: Legging Into April Puts

by Dan February 12, 2016 11:58 am • Commentary• Trade Ideas

Shares of JP Morgan have shown incredible relative strength to every major bank stock the world over, only down 19% from its 52 week highs and down about 14% in 2016.  In the U.S., large money-center peers Back of America (BAC) is down 36% from its 52 week highs, down 30% in 2016, while Citigroup (C) is down 39% from its 52 week highs and down 28% in 2016.

Looking farther afield, I can not find a single other mega-cap bank stock on the planet that is above its August 24th, 2014 flash-crash low, like JPM is:

JPM 3 year chart from Bloomberg
JPM 3 year chart from Bloomberg

I get the reasons for the relative out-performance. It was deemed the safest financial institution on the planet during our financial crisis in 2008/09, with low leverage ratio, cheap valuation, management deemed to be best of breed etc etc.  I get all of that, but the price action in global banks is certainly suggesting something is not right. The rate, regulation and political environment is not exactly conducive to banking profits, and I’m hard-pressed to see how JPM  does not test its 52 week low before bank stocks finally bottom.

Oh and yeah the chorus of peeps telling you how well capitalized, how cheap U.S. banks are and the fact that the problems causing the poor price action here in the U.S. is not emanating from the U.S., they are the same peeps that told you all was good in past crisis. The fact is that there is NO crisis starting here in the U.S., but I have no idea why most U.S. banks act like something evil is going on. And you, nor I know the truth.

BUT, JPM the stock is up 8% today on news that CEO Jamie Dimon recently bought 500,000 shares in the open market, my comments from earlier (here):

JP Morgan CEO Jamie Dimon bought 500,000 shares of his stock, worth about $27.5 million.

That’s a lot of money. But remember, Dimon’s estimated net worth is more than a billion dollars and he made $27 million last year alone. So in the face of a yet disclosed crisis in his industry, or at least a crisis in confidence in bank stocks, Mr. Dimon is merely taking a page out of the financial crisis playbook. He’s providing the ultimate vote of confidence by buying his own shares in the open market.

Mr. Dimon is not going anywhere, he knows that barring some sort of fraud or massive mismanagement he will be the CEO of JPM for as long as he wants. JPM’s stock will be worth more than it is now at some point in the future, so he might as well buy his own stock. What else is he gonna do with all that money? Leave it in his account at Chase and earn nothing? I don’t want to be too dismissive, that is clearly a fairly hefty vote of confidence by Mr. Dimon, but it should not give you the false confidence that there is suddenly a floor in the stock.

A follow through into early next week could provide a great short entry for traders who think that the worst of the selling is not over, the source of global bank stock weakness has not yet been revealed, and two upcoming events could serve as negative catalysts for JPM, finally causing a breakdown to long term support near $50, with lower lows to follow:

First, the capital plans (stress tests) by major U.S. banks to the Federal Reserve by April 5th, which the Fed has instructed banks to consider the scenario of negative rates.

Second, JPM Q1 earnings and guidance to be released on April 13th.

For those looking at defined risk plays, short dated options prices are through the roof, with 30 day at the money implied vol at levels no seen since 2012 during their own self inflicted London Whale Crisis, but well below the levels during the Euro Sovereign Debt crisis in 2011:

JPM 5 year chart of 30 day at the money implied volatility from Bloomberg
JPM 5 year chart of 30 day at the money implied volatility from Bloomberg

For those like me, who think that today’s bounce is a fade, but could follow through into early next week, it makes sense to finance the purchase of longer dated puts that target April expiration.

S0 what’s the trade? 

*JPM ($57.30) Buy Feb 19th weekly / April 55 Put Spread for $2
  • Sell to open 1 Feb 19th 55 put at 60 cents
  • Buy to open 1 April 55 put for $2.60

Break-Even on Feb 19th weekly expiration:

Profits: Max gain at $55, at $55 or higher the weekly put expires worthless and you own the April for $2.

Losses: Any move higher or a massive move lower (way through the 55 strike) means this trade is a loser, but the most that can be lost is what is paid for ($2).

Rationale – This trade uses near term puts to finance a longer term bearish position in the stock. It is defined risk but offers a lot of optionality once the Feb puts expire as the short premium side of the trade can be continually rolled if need be. The ideal situation for us is a slight pullback towards the $55 strike in the next week leading up to February expiration. If that occurs I can either roll the short put out a month, roll it to April at a lower strike to create a put spread, or even take the profits. The risk to the trade is if JPM continues higher over the next week and leaves me with April puts that are too far out of the money.