Investors on Wall Street have had a dilemma of late with regards to trading bank stocks. For example, JPMorgan Chase & Co. (NYSE:JPM) has had an incredible rally, up 42% in 12 months. Yet, JPM stock still only trades at a price-to-earnings ratio of 14x, which is low by any standard. So even though it has come so far so fast, there is no real reason to sell it.
JPMorgan is the creme of the crop. A pristine bank and it only sells at 1.5 book value. It has an impeccable balance sheet, so management will defend its stock with dividends and buyback programs.
Under the Trump administration, banks have favorable operating conditions. This scenario is the case for almost every major bank.
JPM reported earnings this morning and even though it beat its estimates, investors are not buying the stock yet. And therein lies my opportunity today. I want to capitalize on whatever pause that JPM stock sees in the next few days.
Even though it is cheap already, I will not buy the shares out right and hope for a rally. After all, JPMorgan stock is almost three digits, so mathematically there’s plenty of downside risk. Instead, I will use options where I can to create a sizable buffer just in case there is more trouble ahead for banks then is showing now.
Technically, JPM had been trading inside a tightening range from which a breakout was looming. Expectations on Wall Street were that it would be over $100 per share by the end of the week. The flip side of that range is that upon losing the ascending higher-low trend, it could retest to $94 per share.
While this is not a forecast, it is a potential scenario.
For the next few months, there are several other areas that would be support zones to cover an 8% drop in JPMorgan stock. The key to my strategy today is that I’m willing to own the shares under current macroeconomic conditions should the worst case scenario happen between now and 2018.
I am confident that I would be able to manage out of it for a profit.
Click to EnlargeThe idea is to sell risk below the proven support and to let time do the work. If the price stays above my level, then I would have created income out of thin air.
This way, I get to participate in the bullish thesis without having immediate unprotected risk, especially when equity markets are all time highs.
Bottom Line on JPM Stock
The Trade: Sell JPM Mar 2018 $85 put for $1.50. Here I have an 85% chance that I will retain maximum gains. But if the price falls below my strike, then I own the shares and I will accrue losses below $83.50.
For those investors who want to mitigate the risk of selling naked puts, they can sell a spread instead.
The Alternate Trade: Sell JPM Mar 2018 $85/$82.50. This is also a bullish and it could deliver 15% yield on risk.
In either case I don’t need a rally to profit. In fact, JPM stock could fall another 10% from here and I could still retain maximum gains. But regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Learn how to generate income from options here. 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 as @racernic on twitter and stocktwits.