JPM: Volatility play

Note: This analysis has been superceded by "JPM Reconsidered: Volatility play". The stock price reversed, and so did my decision.

The investment banker and financial services company JPMorgan Chase & Co. (JPM), headquartered in Midtown Manhattan in New York City, publishes earnings on Tuesday prior to the opening bell. [JPM in Wikipedia]

Two other symbols, CSX and WFC, met the liquidity requirements for consideration but failed because their implied volatility was low relative to its most recent range, below the 60th percentile.

JPM

Volatility

Implied volatility stands at 28%, placing it in the 65th percentile of the rise from 23% on Dec. 26l 2014 to 31% on Jan. 6.

The one standard deviation range from the current implied volatility, encompassing 68.2% of trades, suggests a potential gain or loss of 4.8% in the next 10 days, until options expire, and the two standard deviation range, covering 95% of trades, of 9.28%.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	54.78	57.21	60.79
Lower	49.92	47.49	58.27

Implied volatility 1 and 2 standard deviations; chart support and resistance
Elliott wave analysis of the longer-term chart, on the left, shows JPM within a mature 3rd wave of a rise from October 2011. The internal count of wave 3 is poorly differentiated. However, the form of the wave suggests a slowing of the rise preparatory to a reversal. However, JPM will not have swung into a downtrend until the price drops below $54.02, or arguably, the slightly earlier low of $51.44.

Click on chart to enlarge.

JPM 4 years 2-day bars (left), 90 days 4-hour bars (right)

The decline from the Jan. 9 peak of $60.79 shows  JPM in an upward retracement since Monday that has carried the price 2% above the decline's low, $59.27.

The primary trend is clearly down. The immediate trend is up. I must judge the direction for JPM to be ambiguous. The rating from Zacks Investment Research is neutral, providing no real guidance.

Earnings over the past year have all produced immediate upward movements. Given the fact that the macro-trend from 2011 is up, and the heavily weighted immediate trend is also up, my inclination is to construct a bull play.

The Trade

JPM has liquid Weeklys in its options inventory, so I shall work with the JAN4 series, which trade for the last time on Jan. 23, 10 days hence.

The standard deviation ranges are skewed to the downside. With this options grid, the skewing forces me to leave much of the 1SD range unprotected in a bull play. And indeed, the grid forces me to pick a low probability strike price in order to get an acceptable risk/reward ratio.

Bull put spread, short the $59.50 puts and long the $58.50 puts sold for credit and expiring Jan. 23 Probability of expiring out-of-the-money

JAN4	Strike	%
	59.5	50.94

The risk/reward ratio of the proposed trade is 19:10, or very close to a 2:1 ratio, compared to the 3:1 or 4:1 that I usually end up with. However, the chance of expiring in the money for maximum profit is nearly 50% -- even odds.

Decision for My Account: SUPERCEDED, see the note at the top of this analysis

There is a correlation among the risk/reward and the odds of expiring in the money for maximum profit -- the lower the risk, the lower the likelihood of a profit. This proposed trade leaves 27% of the chart range unprotected, and 19.9% of the one standard deviation range.

If the chart had a strong presumption of an upward move I would take the trade. But it doesn't. The decline up until yesterday weakens the impact of the one-day rise and leaves me awash in uncertainty over the trend.

Given that degree of uncertainty and then inability to construct a reasonable hedge on the options grid, I've decided against taking the trade.

-- Tim Bovee, Portland, Oregon, Jan. 13, 2015

References

My volatility trading rules can be read here. For a discussion of the rationale behind the rules, see my essay, "Rules for very short term trades".

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading. 

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.


Alerts

Two social media feeds provide notification whenever something new is posted.

• On Twitter, Follow Tim Bovee: https://twitter.com/TimBovee
• On Facebook, Like Private Trader: https://www.facebook.com/PrivateTrader

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

License



All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.

Based on a work at www.timbovee.com.