How To Protect JPMorgan Prior To Earnings Release

Jul. 5.12 | About: JPMorgan Chase (JPM)

JPMorgan Chase (JPM) has been in very hot water lately, and probably undeservedly so. Warm water might be deserved at this point, but not the scalding hot water as presented by the media. The company announced in May the bank had lost $2 billion related to credit derivatives. Some estimates now peg the loss to be as high as $9 billion. Since the announcement of the loss, the company's market capitalization has dropped by $40 billion ... seems a little overkill. A loss of $2 billion on a portfolio of $100 billion is 2%. When looked at in context of a $100 billion portfolio, the $2 billion does not seem so extreme, as the stock market can move as much as 2% in a single day. I don't see the media pundits getting in a tizzy as big as they did for JPMorgan Chase when the stock market moves down 2% in one day. Now, a $9 billion loss, that's a different matter.

JPMorgan Chase is now involved in some turmoil related to potential energy-market manipulation. The U.S. Federal Energy Regulatory Commission is investing potential manipulation related to the power markets of California. Doubtful the energy-market manipulation can come close to Barclays' (BCS) involvement in rigging the London InterBank Offered Rate (LIBOR), where Barclays agreed to pay U.S. and British regulators $450 million in penalties.

In JPMorgan Chase's Q1 2012 earnings call held on April 13, 2012, the company reported revenue of $27.4 billion which was an increase of 6% year-over-year and 24% quarterly. The company reported solid performance across most business segments and noted strong results in investment banking and significant improvement in mortgage banking. On the housing segment, the company noted housing inventory, delinquent loans and charge-offs are all coming down.

JPMorgan Chase's stock price has been on quite a roller coaster over the last year and is currently near its 200 day moving average as shown below:

With JPMorgan Chase's upcoming second quarter earnings update scheduled for July 13, 2012, an investor in the company might be a little queasy with all the turmoil surrounding the company of late. An investor in the company might consider a protected covered call or collar in order to position for a potential return, yet remain protected in case the company reports some bad news. A protected covered call or collar may be entered by selling a call option against a stock and using some of the proceeds from selling the call option to purchase a put option. The put option provides protection or "stock insurance" in case the price of the stock drops significantly. The nice thing about the protected covered call, is the insurance provided by the put option, is paid for by selling the call option.

Using PowerOptions, a number of potential protected covered call positions are available as shown below:

Click to enlarge

A protected covered entered by selling the 2012 Aug 34 call option for $1.96 against a long position against the stock, and purchasing a 2012 Aug 31 protective put option for $0.52 looks attractive, as the potential return is 2.5% (21% annualized) and the maximum potential loss is 6.6%. So, even if the stock price plummets to zero, the maximum potential loss is 6.6%.

Trade

  • Long JPM stock (existing or purchased)
  • Sell 2012 Aug 34 Call at $1.96
  • Buy 2012 Aug 31 Put at $0.52

A profit/loss graph for one contract of the JPMorgan Chase protected covered call is shown below:

For a stock price below the $31 strike price of the put option, the value of the protected covered call remains unchanged. If the price of the stock increases to around $38, the position can most likely be rolled in order to realize additional potential return.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.