JPM: Opportunity or Trap?

Good Evening, Friends. Here’s hoping that everyone has had an excellent weekend. I found last week to be stressful, since I have both bull put spreads and bear call spreads on in various stocks/ETFs, and it seemd that at various times I had to worry a little about all of them. Since my net positions had been leaning somewhat long, which was making me uncomfortable, I used the intraday rally on Friday to lighten up – not, unfortunately, at the day’s very best levels – and ended the week slightly net short. There are lots of things that are making market participants nervous; Greece, Spain, the state of the U.S. economy (seems so-so), the condition of the Chinese economy (seems to be weakening, albeit from a high level) and, more recently, JPM and its fellow banks.

If you’ve been reading or listening to the news, you’re no doubt aware that JPM, in an attempt (it would appear on balance) to hedge part of its enormous commercial loan portfolio, got overly cute with instruments that have proved very tough to exit. The bank has numerous hedge funds gunning for those positions, which will make unwinding them even more expensive. The hit at the moment is expected to be roughly $2 billion, but I’ve seen guesses that by the time the dust settles $3 bn will be more like it.

JPM made over $15 billion in net income in its fiscal 2011 year, so while $3 billion is more than a flesh wound, it can be withstood. The stock dropped by 9.3% on Friday, and pays a 3.25% dividend at the current rate (the 30-year Treasury bond pays 3% currently). It won’t make as much money this year as was assumed, but it won’t be losing. So, in a nutshell, is it worth buying? Apart from the technical picture, one unknown that will work its way into the price only over time is the extent to which increased regulatory oversight will make it more difficult for the bank to make money going forward. The market thus far says that’s worth 9.3% or so, but I wouldn’t assume that’s the last word.

Technically, the stock is now in a downtrend, and it would appear, given where the moving averages and the 50% retracement levels are on the daily chart, that it might under favorable market conditions be able to claw its way back to somewhere around 41. That wouldn’t be a bad move from Friday’s close of 36.96 (let’s call it 11%), and of course the dividend yield is attractive. Still, a look at the weekly chart on the right indicates that the stock was a lot lower not too long ago, and trying to catch falling knives isn’t usually a recommended activity.

One way to obtain some additional cushion would be to get long by selling June 37 puts; as of Friday’s close, these were quoted at 1.57 bid. If put, the premium earned would provide an additional 4.2% in downside protection, for a net cost (using Friday’s closing prices) of 35.39 a share, and a dividend yield (assuming it remains the current 0.30/quarter) of 3.34%. One downside to this approach, of course, is that if the stock rockets higher, all that can be earned by the put seller is the original 1.57. Still, that’s 4.2% for slightly more than a month’s work, a nice annualized return of roughly 45%, again based on Friday’s closing prices.

For those tempted to bargain hunt, it might be prudent to take only a small starter position; there should be time to add if the stock behaves well. I’d like to see the stock move above Friday’s high of 37.99, which would make me more confident in using Friday’s low of 36.62 as a reference point for a stop, perhaps something just below 36.50. A buy at 38.05 that was stopped out there would represent a 4.1% loss. If I was long via short puts, I’d be inclined to cover the puts  if that level on the underlying stock was broken, as well.

I think that there’s a lot of value in JPM at the current price (unless the regulators start looking for CEO Jamie Dimon’s head; in that case, I wouldn’t get near it). Still, in order to make money, people with far deeper pockets than mine need to agree. Stochastics on the daily chart are, not surprisingly, way oversold, and assuming that Friday’s low holds come Monday, there’s a convenient reference point for stops, so the risk can be well-defined. This remains a volatile and potentially risky endeavor, however, with plenty of headline risk, so if I end up doing anything with the stock, it will consist of half or less of what I would normally consider to be a full position.

Best of luck in the week ahead!

P.S. I’m writing this on Monday evening; JPM continues to trade weakly, and never came close to moving above Friday’s high. Volume today was less than half of Friday’s, and the market overall was soft, but the close in JPM was within three cents of the low of the day, hardly a signal that buyers are beginning to come in. I continue to be interested, but only when the stock shows some strength by moving above the previous day’s high, at which point I will continue to use the most recent low as a reference point for a stop. In fact, since today’s open represented a small gap lower, I would want to see that filled. I’ve left an alert at 36.62 (the low from Friday), 2.4% above today’s low, so that I can keep an eye on the stock if it does start to make a move higher.

About the Author Brian Keith

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