Option Trade – JPMorgan Call Spread
With the recent downward moves in the market, options trading investors have to circle the wagons a bit. A call spread has a defined loss and defined profit. Any trade you put on these days should be spreads or have limited exposure. That way, you already know the worst-case scenario. In addition, at uncertain times like this, best of class is where you want to be. If the market continues to drop, the best of class stocks will suffer less. If the market goes up, the best of class will be out front leading the charge. If the market stays in this range, the best of class will hold their value best, while smaller less cash rich competitors will need to adjust.
JPMorgan (NYSE: JPM) is currently best of class in the not-so-great financial sector. They are the best capitalized and make decent money (compared to their competitors) on non-risky business such as trading. (Note: JPM has a large trading operation, but the revenues are not as significant to the bank as it is to others in this space, such as Goldman Sachs (NYSE: GS), Credit Suisse, and UBS (NYSE: UBS).
We will buy an in-the-money JPM Aug 40 Call and try to finance part of that premium with selling a JPM Aug 45 Call. Everything in this trade – the cash outlay and the maximum loss — is limited and known before we get in. Knowing the worst-case outcome is important in trading days like those that we recently have had.
CALL/SPREAD TEMPLATE
STOCK/INDEX: JPMorgan (NYSE: JPM)
STOCK PRICE: 41
BUY/STRIKE/MONTH/PRICE: 1 Aug 40, 2011 40 Call @ $3.05
SELL/STRIKE/MONTH/PRICE:1 Aug 45, 2011 45 Call @ $1.09
NET COST: $3.05 (Premium for the 40 call) – $1.09 (Premium for 45 call) = $1.96
STOCK COST BASIS
BREAKEVEN: The 40 Strike + Net Premium paid for the call spread = $41.96
MAX PROFIT: Difference between strikes of 40 and 45 = 5
MAX LOSS: Limited to the premium paid for the call spread = $1.96
TRADE COMMENTARY: This bullish call spread strategy reduces upfront cost in order to benefit in a rise in stock price. The Profit potential is limited while the potential loss is what you paid for the spread.
** Always remember, one option contract is equal to 100 shares of stock
Stutland Equities is a premier futures and options trading company on the Chicago Board Options Exchange. Founded in 2005 and headquartered in Chicago, Stutland Equities specializes in volatility arbitrage across multiple asset classes.
