A Tale of Two Banks… It was the best of breeds (JPM), it is the worst of Breeds (WFC)

by Dan May 6, 2020 12:43 pm • Trade Ideas

Yesterday in my post, Wells on Notice yesterday I discussed the Sell rating that was slapped on shares of WFC on Monday by UBS, with the analyst expecting 35% decline in the next 12 months, from the then price of $29, which was also down about 50% from its 2018 highs. I also stated:

If WFC’s is going to $19 in the next 6 to 12 months, then the XLF is going to be a teenager again, possibly as low as its 2016 lows near $16 (my recent post on XLF here). The XLF has important technical resistance at $24 and support between $18 and $16:

The second-largest component in the XLF (behind #1Berkshire Hathaway at 14%) is JP Morgan (JPM) at 12%. JPM considered best of breed when it comes to the moneycenter bank stocks, is faring better than worst of breed WFC, only down 35% on the year, but not a whole heck of a lot better when you consider the differential in where both are trading relative to their book value (WFC at .66 and JPM at 1.18). WFC is not likely to trade at too much more of a discount to its peers, while JPM has some room to the downside if the recession we are in now goes deeper and lasts longer than the SPX down 11% YTD might suggest.

From purely a technical standpoint, shares of JPM were recently rejected at prior support at $105 (now resistance) and has just broken the uptrend that has been in place since the March lows, now up only 17% from those levels, vs the SPX’s 30% gains from its March lows:

 

Despite being down considerably from the March highs, short-dated options prices remain very elevated from their 52-week lows in January, with 30day at the money implied volatility in JPM at 47%, up from ~14%, making long premium directional strategies challenging:

 

Just to highlight how expensive near-dated at the money options are in JPM if you look at the July options, that will catch their Q2 earnings release, the July 90 straddle (the call premium + the put premium) with the stock at $90.50, is offered at about $15, or about 16.5% of the stock price. Driving home my point above that the S&P 500’s 11% YTD losses do NOT reflect current financial conditions or risks.

Put another way, if you wanted to make an at the money bearish bet in JPM with the stock at $90,50 and you wanted to capture Q2 earnings, and you wanted to do so with defined risk, you could buy the July 90 pit for ~$7.50, needing a break-even down at $82.50 on July expiration. You could target the prior low at $77 and buy the July 90 – 75 pt spread for $5, with breakeven at $85 and a max gain of $10 if the stock is $75 or lower on July expiration, risking 1 to possibly. make 2 if the stock is down 16% in two and a half months… not a great risk-reward in my opinion. Hedges are becoming harder and harder and expressing long premium directional views with defined risks are being left for those with high conviction and understand the dynamics of risking what you are willing to lose if you wrong.