Wednesday, November 7, 2012

JPM: Political dive

A fascinating morning, with the S&P 500 diving 2.8% below yesterday's close.

Was it simple-minded analysis of the election results? (Republicans good, Democrats bad.)

Was it algorithms that built the election outcome into their trading rules?

Was it a coincidence? A fluke? A continuation?

The World Wonders. Who knows why the markets do what they do? Perhaps the best answer is, "All of the above."

The fact is that the S&P 500 hit a swing high of $14.74 on Sept. 14, and has been in a downtrend ever since. The index moved below its 20-day low on Oct. 12, triggering a bear signal under my rules. And today it moved below the 55-day low, triggering a bear trade among the more cautious Turtle Trading fans.

The health-insurance companies took a bit of a hit, but that was all ready underway. And so did the financials, which have also been ina downtrend since September.

Amid all the noise, JPMorgan Chase & Co. (JPM) came closest to satisfying my requirements, and also it allowed me to play the politically driven financials decline.

JPM pierced the lower boundary of its 20-day price channel, $40.87, triggering a bear signal. The move to a low today (so far) of $40.31 set a lower low following yesterday's lower high in a downtrend that began Oct. 17 from a swing high of $43.54.

JPMorgan Chase, headquartered in New York, is the largest bank in the United States measured by assets. Forbes has declared it to be the second largest public company in the world. It has its fingers in most financial pies. It is, in short, a player.

The political story behind JPMorgan Chase and the rest of big finance is that the Obama administration wants to impose stricter regulations on their business.

The problem with trading on that story is that the likelihood of increased regulation would change not a bit no matter who won Tuesday's election. Republicans control the House. They can block regulatory moves originating in the Democratically controlled Senate or White House. Had Gov. Romney won, then the Senate would be the effective blocking body.

So in terms of story, I treat today's large downward move -- 6.4% below yesterday's close -- with a lot of caution, and indeed the price has retraced to slightly above the breakout level.

Indeed, if you listen to analysts, you'll be bullish on JPM's prospects. The analyst enthusiasm index stands at 26%, up from 17% three months ago.

I wouldn't call JPM a growth stock by any measure. The company's return on equity is 10% -- more a slow and steady level -- and debt is way high, like that of most banks, standing 38% higher than equity.

Earnings have risen the last four quarters, although the two middle quarters formed a plateau. So far there's no reasonable basis to declare that earnings have been accelerating, although the most recent quarter, which saw a 22% rise, a year from now could well appear as a take-off point.

Institutions own 70% of shares, and the price is above par: It takes $1.72 in shares to control a dollar in sales.

JPM on average trades 18.5 million shares a day and supports a wide selection of option strike prices with open interest running at five figures near the money. The front-month at-the-money bid/ask spread for puts is two-third of a percent.

Implied volatility stands at 29%, in the bottom half of the six-month range. It has been rising at a shallow angle since mid-October.

Options are pricing in confidence that 68.2% of trades will fall between $37.48 and $44.40 over the next month, for a potential gain or loss of 8%, and between $39.28 and $42.60 over the next week, for a gain or loss of 4%.

The market for options is hopping, with calls running at more than four times their five-day average volume, and puts at nearly three times the average.

Today's fair-price zone on the 30-minute chart runs from $40.51 to $41.30, encompassing 68.2% of transactions surrounding the most-traded price, $40.97. The zone width is 2%. With two and a half hours to go before the close, the stock is trading just below the most-traded price.

JPMorgan Chase next publishes earnings on January 9. The stock goes ex-dividend in January for a quarterly payout yielding 2.93% at today's prices.

Decision for my account: I took the trade on the basis of the signal and supporting confirmation. I structured it as a bear call spread, short the December $42 call and long the $43, for a 43% yield on risk. The structured places the break-even point at $42.30, slightly below my standard initial stop/loss of twice the average daily trading range, which worked out to $42.38.

I don't set stops on vertical spreads. Any additions to the position will be in the form of long put options with a delta of around 70.

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 decision decisions for his or her own account, and take responsibility for the consequences.

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