The markets continue to head back toward all-time highs even in the face of dramatically lower earnings expectations. Valuations and price action are approaching extremes, especially in the mega-cap tech names. Getting out of stocks and into bonds is not feasible given that interest rates are near zero. Rotating out of the big winners and into the underperformers, however, is looking very feasible. With that in mind, expect JPMorgan Chase (NYSE:JPM) stock to be a relative outperformer over the coming months.
The top five stocks, by market capitalization, in the S&P 500 now account for over 23% of the index. That’s an all-time high.
So who makes the fab five? Of course we have Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), and Facebook (NASDAQ:FB). This group is up 15% so far for the year.
The rest of the S&P 500 is still down 8% year-to-date. The price-sales ratio for Microsoft is now over 10 and at the highest levels seen in the past decade. Chasing these names now will likely end badly. That’s why it’s time to focus on adding higher-yielding underperformers to gain exposure now.
Here’s Why JPM Stock Will Outperform Soon
The major money center banks like JPM are finally beginning to show some life on the chart.
Moving average convergence/divergence just went positive and generated a “buy” signal. Momentum is now positive as well. The nine-day relative strength index set a series of lower highs. Plus, JPM stock is back above the 20-day moving average of $91.51 which should provide support.
Still not happy? Shares also pierced through the downtrend line, which is yet another bullish sign. The first major resistance area for JPM — if it does have a meaningful breakout — is $104.
Bank stocks have also been huge underperformers to the Nasdaq Composite names since the novel coronavirus emerged in March. The banking index has floundered in that time frame while Nasdaq 100 index has flourished.
Normally, these two are fairly well correlated, but lately that correlation has broken down and is now at an extreme. Look for the relationship to begin to revert back. Bank stocks should start to relatively outperform the Nasdaq in the coming months.
The big banks also pay very attractive dividends with low payout ratios. This low historic payout ratio means the banks can continue to maintain those dividends even if earnings don’t support them.
Currently JPM stock pays $3.60 annually in dividends, which equates to a 3.6% dividend yield. This is well above the roughly 2% yield for the S&P 500 and is at a major premium to the 10-year U.S. Treasury yield of just 0.65%. This should serve to staunch any major downside for JPM stock.
Implied volatility is still at rather rich levels for JPM. This favors option selling strategies when constructing trades. So, to capture the dividend and also reduce risk, a covered call trade makes sense. It also prepositions to be a seller on a decent rally.
How to Trade JPMorgan Here
Buy JPM stock and sell the JPM January $105 call for a $90 net debit
Selling the January $105 calls brings in an additional $7.50 in option premium. This serves to lower the initial cost by nearly 9% although it does limit the potential upside gains as well. The short $105 strike price is struck near the major resistance area at $104.
There are three dividend payments between now and January expiration which will bring in an additional $2.70 in income. The combination of dividends and option premium totals just over $10 which equates to a 10.7% standstill return or 17.6% annualized.
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 weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.