JPMorgan Chase: Options Are Best Way To Play This Undervalued Stock

| About: JPMorgan Chase (JPM)

The market is getting downright ugly as worries from Europe overtake any positive news coming from the U.S. economy. No sector has been hit harder than the banking sector. This has left many banks selling way under book value and at rock bottom valuations. Unfortunately, it is hard to take any outright position in them as the sentiment is horrid and the volatility is very high. I think the way to overcome these headwinds is by employing an option strategy to pick up a great return while limiting downside risk. I am using options to establish a position in the best run domestic bank, JPMorgan (NYSE:JPM).

Option Strategy: Sell the Jun 12 $25 puts and buy the June 12 $22 puts via a bull market put spread for a net credit of a $1.

Scenario 1: JPM holds a minimum $25 level when the option spread expires in June 2012. In this likely scenario, I make my dollar share spread while only tying up $2 of collateral in my brokerage account. JPM also has great liquidity in its options which provides narrow spreads.

Scenario 2: JPM continues sells off over the next seven months as the crisis in Europe ends in disaster. In this situation, I acquire JPM for a price adjusted $24 a share while limiting my maximum loss during the time of the option spread to $2 a share.

5 reasons JPM is a long term bargain at $28 a share:

1. Management is generally acknowledged as one of the best in the business. Insiders also made some significant buys of new stock at higher levels in August.

2. JPM sells at just .6 times book value and yields 3.5%.

3. With the exception of two months in the depth of the crisis in 1Q2009, JPM has bottomed just under $30 over the last five years (See Chart).

(Click to enlarge)

4. JPM has a much better balance sheet and less leverage than it did during the financial crisis of 2008 and goes for less than 6 times forward earnings.

5. JPM is deeply under analysts’ price targets. Credit Suisse has a price target of $58 on JPM and the median analysts’ price target on JPMorgan is $47.

Disclosure: I am long JPM.