Last week, JP Morgan (NYSE:JPM) reported a $2b trading loss in their Chief Investment Office (NYSE:CIO) segment. The CIO manages the risk positions for the bank, and needless to say, they didn't do a good job. The market responded very negatively the following day sending the shares down nearly 10%. In this article I will give you six reason not to worry about this trading loss, and through that show that the market has overreacted to this news. I will then present both short-term and long term strategies to capitalize on this illogical drop.
NB: I will make a lot of references to both the most recent 10-Q (10Q), or the most recent annual report (NYSE:AR), I will quote the page number, and if you click on the link you will see the relevant passage I am discussing highlighted.
Six Reasons Not To Worry
1. On page 33 of the most recent 10-Q JPM reported that their CIO portfolio had average assets of $361b. A $2b loss to this portfolio only makes for a half a percent (.5%) loss.
2. In last year's AR JPM reported a $1.9b loss in the Fx derivatives portion of their CIO portfolio -- nearly equal to the current loss.
3. Last quarter, JPM realized a $1b gain in their available for sale (AFS) portfolio, which helped offset their $2b trading loss they suffered in their synthetic credit position.
4. JPM has an overall $8b unrealized gain in their CIO portfolio, including the current trading loss.
5. In the past quarter JPM, even with the trading loss earned $5.3b.
6. Last year, JPM made nearly $19b in profit and CIO accounted for $1.3b of that gain, or a little more than 5%. Even assuming a complete loss of $2b for CIO, or a $700mm swing into a loss, JPM would only lose 3% in post-tax earnings. (I am ignoring the tax implications of this loss)
From the above, I think we see that this trading loss doesn't impact JPM's current portfolio significantly, both from the perspective of past CIO portfolio losses, current overall CIO portfolio performance, and overall JPM performance.
How To Play This Theory
On the simplest level, you buy the stock now at a 10% discount, and wait for it to rise long term. If you want to get a little fancier you can short Jan 13 @37 puts, which will give you $445 in premiums, and presumably little downside risk. However, if you believe that JPM has no handle on this situation, and prices will continue to fall either in the short term or long term, then you could find yourself putting up a lot of collateral, and possibly losing it. An investor with a lower risk profile could buy long dated near/in the money calls, which could yield strong results.
JPM's management showed a lot of courage when they made a big deal out of this loss, at a time when they face continued criticism from both the public and DC politicians. The fact that they handled this in such a transparent way, at an inopportune time, shows their dedication to their shareholders, and their desire to right the ship. JPM's management managed the firm brilliantly during the depths of the financial crisis, at a time of extreme systemic and internal risk, when the USA and its financial leaders truly found themselves on the brink. Considering the outstanding job JPM did during a much more difficult time, I think we can feel confident that they will steer the bank in an effective way during a much less severe crisis.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.