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On Thursday, May 10th, JPMorgan Chase (JPM) announced $2 billion in trading losses. The details of the loss are widely available on the various new wires and fundamental opinions on the outlook for the stock are numerous. The bottom line is that JPM should be solid enough to withstand the losses.

The sell-off in the stock on Friday has set up some short term option trades with favorable characteristics. Friday's close for JPM was $36.96. The down move measured in standard deviations was -6.56 standard deviations. Some reversion to the mean should be expected over the next few weeks.

The May/June 37 calendar put spread has some favorable characteristics. With a calendar spread, if we buy the longer dated option and sell the near term option, the risk is limited to the amount that we pay for the position, so our worst case scenario is known and can be controlled. If we set our maximum loss at $2,000, which would be 2% of a hypothetical $100,000 trading account, we'd sell 25 May 19th $37 puts for $0.79 and buy 25 June 16th $37 puts for $1.59. The net debit is $0.80 cents. The theoretical profit is $1,029 and the maximum gain is $1064.87. The implied volatility of the short options is 36.08% and the implied volatility of the long options is 33.85% for a difference of 6.59%. The trade is essentially delta neutral at the onset, the May puts have a 50 delta and the June puts have a 48 delta.

Some traders use the rule, "if you put in on as a spread, take it off as a spread." I think that can be a good rule, however I have had success legging in and out of spreads as well, so I think that the exit strategy should be left to the individual trader. If the spread narrows sufficiently you may want to take profits or partial profits, in other words sell off some of the position at profitable prices when the opportunity arises. If you hold until the May 19th expiration you want the June put to be worth at least $0.80 in order to break even. If JPM rises very rapidly you may want to exit the position or make some delta adjustments and create a complex position. When making delta adjustments, there are almost unlimited variations to consider; use a theoretical profit calculator to find the adjustments with the most favorable characteristics.

One strategy that I have had success with when using calendar put spreads that don't become profitable before the first expiration and where the underlying stock is below the short strike price, in this case $37, is to allow the shares to be put to me. In this case, if JPM is below $37 on May 19th, I'll get assigned 2500 JPM at $37, but I'll own 25 JPM June $37 puts and my cost for the puts is $0.80, so my worst case loss in still $2,000. Now I'll need JPM to rise above $37.80 by the June expiration to break even. If there is an opportunity in that time frame to sell a June $37 call for more than $0.80, that will give you the ability to trade into a profitable conversion.

(click to enlarge)

(click to enlarge)

Source: JPMorgan Calendar Put Spread