With the ouster of aluminum producer Alcoa (AA) from the Dow Jones Industrial Average last month, JPMorgan Chase (JPM) now holds the honor of being the first Dow component to enter the earnings confessional this season. As the nation’s largest bank, JPMorgan also is the first major financial institution to report earnings — alongside Wells Fargo (WFC) — meaning JPM’s quarterly report could set a considerably important tone on Wall Street.
For the record, the consensus is expecting JPMorgan to post a profit of $4.8 billion, or $1.20 per share, down from $5.3 billion, or $1.40 per share, a year ago. Revenue is expected to come in at $24.14 billion for the quarter.
Unfortunately for investors, digesting JPMorgan’s quarterly report won’t be as simple as looking at the bottom-line figures. The company also is racking up quite a legal bill in its battle with the Department of Justice regarding allegations that JPMorgan knowingly sold faulty mortgage-backed securities in the run-up to the financial crisis that sparked the 2008 market crash.
Those woes could be over soon, as reports trickle in that JPMorgan is close to settling with the DOJ (though some hurdles remain). The price tag for the settlement reportedly could be as high as $11 billion, with at least $4 billion of that set aside as a form of consumer relief.
Despite the high price tag, the sheer relief of ending the DOJ battle could be enough to spark a brief rally for JPM shares.
Turning toward the sentiment backdrop, expectations are high within the brokerage community. Specifically, JPMorgan’s whisper number for third-quarter earnings comes in at $1.33 per share — 13 cents better than the consensus, according to WhisperNumber.com.
Elsewhere, 24 of the 31 analysts following JPM rate the shares a “buy” or better, vs. only six “holds” and just one “sell.” This bullish bias is also reflected in the consensus 12-month price target of $63, a figure that represents a 24% premium to JPM’s close at $50.75 on Wednesday.
Bullish sentiment is thick on the options front, too. Some 72,212 JPM calls are open in the weekly October series, vs. about 36,040 put contracts open. The result is a very optimistic weekly October put/call open interest ratio of 0.5, with calls doubling puts among options set to expire at the end of the week.
Pulling back for a broader time frame, we see similar activity in the October/November series of options. Currently, call open interest in the front two months totals roughly 166,000 contracts, compared to put open interest of about 103,000 contracts. The resulting put/call open interest ratio of 0.62 is only modestly less bullishly inclined that JPM’s weekly October ratio.
For comparison, peak call open interest totals 54,515 contracts at the out-of-the-money Oct 55 strike, with the Oct 52.50 coming in at a distant second with 31,426 contracts. On the flip side, peak put open interest totals 39,466 contracts at the in-the-money Oct 52.50 strike, with another 26,688 put contracts open at the out-of-the-money Oct 50 strike.
Click to Enlarge From a technical standpoint, JPM stock deserves some of the optimism it has garnered among options traders and analysts. JPMorgan has rallied nearly 50% off its July 2012 bottom near $30, bolstered by support from its 10- and 20-week moving averages. Recent market weakness — driven by uncertainty and confusion out of Washington, D.C. — has pushed the bank below the formerly supportive trendlines, but JPMorgan stock still is holding firm above its 200-day moving average and round-number support at $50.
Overall, I wouldn’t expect a sizable short-term rally to materialize unless JPMorgan discloses some sort of sweetheart deal with the DOJ — which doesn’t seem very likely. Furthermore, weekly October option implieds are pricing in a potential post-earnings move of only about 3.3%. This places the upper bound near $52.67, while the lower bound rests at $49.33.
For those looking to enter an options trade ahead of earnings, following the bullish lead in the options pits seems safe for the time being. Hedging your bets with a bull call spread and placing the trade in the back-month November series would also provide a bit more coverage should things go pear-shaped because of Congress.
As such, a Nov 50/52.50 bull call spread looks like it has some potential. This spread currently is offered at $1.50, or $150 per pair of contracts. Breakeven lies at $51.50, while a maximum profit of $1, or $100 per pair of contracts, is possible if JPM closes at or above $52.50 when November options expire.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.