Shares of JPMorgan Chase & Co. (NYSE:JPM) have been absolutely on fire over the past several weeks, rising 10% since making a low around the $88 level on Sept. 8. Much of the rally is predicated on the recent rise in interest rates and a more hawkish tone out of the Federal Reserve. The newly proposed Trump Tax Plan is also being viewed as a big benefit to banks. While both of these may be a decided bonus to banks and J.P Morgan, the reaction in JPM stock has become way overdone. I look for a pullback in J.P Morgan over the coming weeks.
Banks make a large percentage of their overall revenue on Net Interest Margin, or NIM. This is simply the difference between what banks receive on longer term loans versus what they pay out on shorter term deposits.
Banks such as J.P. Morgan are therefore highly correlated to interest rates, as the comparative chart shows. While the 10 year Treasury yields have certainly risen over the past month, JPM has risen even more dramatically and is now trading at a big premium to the normal relationship. I expect this divergence to begin to converge with JPM under performing over the next several weeks.
Click to Enlarge The difference between the yield on the shorter-term two-year Treasury and the longer-term 10-year Treasury is a good surrogate for the NIM that JPM receives. While l onger-term rates have risen, shorter term rates have risen as well.
The 10-2 Treasury spread is actually at the lower end of the range over the past year meaning NIM has likely narrowed, not increased. The benefit of higher rates has not played out to the extent the market has priced it for JPM.
The recent Trump Tax Plan is rumored to be a boon for banks. Of course, getting the tax reform agenda passed, especially one favoring the vilified big banks, is quite another matter. Just remember how well Obamacare repeal went.
Let us also not forgot that the long-promised border wall is exactly that, just a promise. I think the rumored tax benefits that have taken bank stock to all time highs will be watered down at best.
Click to Enlarge JPM stock is also getting overbought on a technical basis with a 14-day RSI now above 70. The previous two instances when J.P. Morgan was this overbought proved to be significant short term highs in the stock price. Shares are also trading at a huge premium to the 50-day moving average of $92.27 which has also signaled caution in the past. I look for JPM to retrace towards the $94 level over the coming weeks.
To position for a pullback in JPM, a put diagonal play makes sense.
JPM Stock Trade Idea
Buy JPM Nov $95 puts and sell JPM Oct $94 puts for a $1 net debit.
The spread is 13 deltas net short at trade inception. Maximum risk is the premium paid of $100 per spread. Ideally JPM closes near the $94 level on October expiration.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at timbiggam@gmail.com.
