JPMorgan Chase & Co. (NYSE:JPM) has had a great rally this year and is now butting up against prior failure levels. Other banks like Bank of America Corp (NYSE:BAC) also are enjoying nice gains off their lows. The exchange-traded fund Financial Select Sector SPDR Fund (NYSEARCA:XLF) is finally showing signs of life.
From here there might be trouble, though. And to prepare for that, I want to try and pick on a few financial stocks. JPM stock stuck out as one challenging highs.
If I am correct that there could be trouble, a stock at its highs is usually one of the first place sellers hit.
Click to Enlarge This is not so as much a short on JPMorgan Chase itself as it is a short on markets in general. The U.S. Federal Reserve will eventually take more steps into their rate hike cycle and that will have a negative effect on equity prices in general. The perception is that Banks profit with higher rates.
So, financials may at first rally with the rate hike but I believe that this will be temporary, as was the case last year. Banks will eventually follow the general equity markets’ move.
JPM Stock Trade
Trade No. 1 — The Bet: Buy JPM Dec $67.50/$65 debit put spread. This is a bearish trade for which I pay per 60 cents contract. This is my maximum potential loss. To profit, I need JPM stock to fall through both legs of my spread before it expires. If JPM stock drops below $65, I stand to gain $1.90 per contract.
I usually like to lower my entry costs by setting an opposing trade. Usually it’s a bullish credit spread. In this case and since markets are currently nervous days ahead of the elections, I may delay the entry a few hours just in case we get a poll report showing a Trump lead.
Trade No. 2 – The Bank (Optional): Sell JPM Nov $66/$65 credit put spread. This is a bullish trade for which I collect 15 cents per contract. Ideally here I need JPM stock to stay above my spread through the November expiration. This has a theoretical 85% chance of success and a 4% price buffer from current levels.
The yield if successful would be 17% on money risked. Ideally I need this spread to expire worthless, at which point I have discounted my entry price for the December short by the 15-cent credit per contract.
This sounds complicated, but the idea is simple: From here, I believe there is more downside risk in JPM than upside potential. I want to capture that move as cheaply as possible.
I am not obliged to hold any of the positions through the expiration. I can close for partial gains or losses at any time.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
