Waiting For The Bottom In JPMorgan

| About: JPMorgan Chase (JPM)

JPMorgan (NYSE:JPM) is one of the few banks to escape the financial crisis of 2009 as a stronger and better capitalized bank. Since the crisis, JPMorgan has been one of the fastest banks to consistently increase its annual dividend rate while still exceeding quarterly estimates. The bank's share price has also rebounded very quickly compared to peers like Wells Fargo (NYSE:WFC), Bank of America (NYSE:BAC), Citigroup (NYSE:C), and Goldman Sachs (NYSE:GS). Lastly, and most importantly, the bank is run by Jamie Dimon, a man who quite possibly could be the smartest man on the street.

As everyone knows by now, JPMorgan announced two weeks ago that the firm had experienced a large trading loss. At the time of the announcement, the loss was estimated to be around $2 billion. As more information has come to light concerning the trading loss, it is now expected to potentially top $5 billion. The details surrounding the trade continue to remain undisclosed, which is only helping to fuel the market's panic as it attempts to find the new 'fair' market value of the stock.

I will be the first to admit that this is not good news for the bank and especially its share price. They have gotten hammered over the past two weeks as the additional details surrounding the trade have slowly come to the surface. Prior to the announcement, the stock was trading for around $41/share with a market capitalization of $156.2 billion. The stock is now trading for around $33/share, with a market capitalization of $125.7 billion. The market's attempt to find the new fair market value of the stock has shaved off $25 billion in value to JPMorgan's market cap.

Over the last week there have been several interviews with Jamie Dimon concerning the loss, Dimon continues to say that he is extremely embarrassed and vows that this will never happen again. There has been a great deal of concern from investors that JPMorgan might cut its dividend as the firm finds ways to raise capital as it works to weather this storm. This past week, Dimon announced that JPMorgan will be suspending the current share buy-back program. Cutting the buy-back program should provide enough capital to the bank that will allow the firm to continue to pay the dividend. To make matters worse, the U.S. government has also announced that it intends to launch a probe into the trading loss in an attempt to try to determine what happened and how (or if) it could be prevented in the future.

Over this last week, as these events have continued to come to the surface, the stock has continued to get punished. After two weeks of constant selling, I feel that the stock is beginning to approach a valuation that is very enticing. As the market continues to have such a negative sentiment for JPMorgan, I feel that there are several factors that the market is overlooking.

  • JPM at its current share price is now trading around 4%-5% below its tangible book value. Buying the stock at tangible book value is a great opportunity for any investor/trader and allows for a high probability of upside.

  • This last year, JPM posted Net Income of $18.976 billion and an EPS of $4.48. With numbers like that, even in a worst case scenario with a $5 billion loss, JPM will still remain profitable.

  • Last year JPM had a positive net change in cash of $32.03 billion, with $95.9 billion coming from its operations.

  • The type of trading that JPM lost its $2-$5 billion on usually makes up only 10% of its average overall revenue.

  • The firm has confirmed that it plans to continue to pay the dividend. At the current share price, the dividend yield is 3.6%.

  • JPM still has Dimon at the helm, which should help the firm weather this storm and ensure shareholders that all actions will be taken to prevent this from happening again

  • Citigroup just upgraded the stock with a price target of $45/share. I usually don't care about these upgrades because they are generally late to the party, but I agreed with this one, so I thought I would include it.

I feel that the market is pricing in a scenario that is extremely unlikely for JPMorgan and which is helping to create this excellent buying opportunity. Now, I am not suggesting that you go out and buy all of the stock you can today and wait for it to immediately start going up. Honestly I think there is still more downside within this stock. What I would suggest for someone interested in playing this stock is to take a look at selling some cash secured or naked (depending on your risk tolerance) puts at a strike price that seems enticing.

I really like the stock at the $29 - $30 level. I would suggest looking at those two strike prices. As for which contract month to look at, I feel that this trading loss is going to be lingering in the news for a while and will continue to negatively affect the stock price. So I would suggest looking at selling some further dated options. I like the September 2012 and December 2012 puts. I have outlined the prices for the various option contracts below at the time of this article.

JPM Puts




$1.40 / 4.8%

$1.60 / 5.3%


$2.20 / 7.5%

$2.50 / 8.3%

Click to enlarge

When I sell puts on a stock that I would not mind owning at a better price I have a few rules that I like to follow. First, I want at a minimum a 3.5% rate of return on the money that it would take to buy the appropriate number of shares at the strike price that the puts were sold at. If I can get a higher rate than 3.5% then that is just icing on the cake. In the case of the September and December $29 and $30 strikes, the return on my money is excellent and exceeds my first rule of 3.5%. With all of the volatility and fear within this stock, the pricing of these options as a seller is extremely ideal.

Secondly, I never sell all of the puts that I want on the same day or at the same strike price. In the JPMorgan example I would suggest selling puts for the same contract months at both the $30 and $29 strike prices. That way if the stock did breach both of those levels at the time of expiration and you were put to the stock, you are in essence dollar cost averaging your entry point through the various option contracts that you sold. This obviously is not taking into account the discount that should be applied to your entry point from the premiums collected from selling the puts.

Lastly, I always want to make sure that if I am put to the stock I am buying the stock at a price point that I would be pleased to own the stock at from a valuation standpoint. I feel that the $29 and $30 per share level is a great level to buy the company at from a valuation standpoint, not to mention that at these levels, the dividend yield that you would be receiving ranges from 4% to 4.1%.

Overall, I feel that JPMorgan is- at this price point- starting to provide some real value and is getting to a point where the downside is becoming much more limited in comparison to the potential upside. Again, I do believe that in the short-term the stock could continue to sell off, but that is why I am suggesting the put option trade. No matter what happens, I believe that this trade is a win-win for the seller who is able to find a way to capitalize off of this extremely oversold situation.

Disclosure: I am long JPM.