This Bank Could Be Starting a Trend
Traders often try to anticipate news. If they are on the right side of the news, they can be rewarded with large gains in a short amount of time. However, being on the wrong side of the breaking story could be costly.
An alternative is to study the news and then take a position. This can also be a rewarding, and less risky approach for some traders to consider.
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“JPMorgan is the largest U.S. bank by assets and a bellwether for the U.S economy and financial sector. It reported strong results across its businesses, with Chief Executive Jamie Dimon citing solid U.S. economic growth, moderate inflation and robust consumer and business confidence.
Even a 10 percent fall in JPMorgan’s trading revenue from a year earlier was viewed as boding well for others, since analysts had been bracing for a bigger drop in fixed-income and equities trading.
“JPMorgan had a positive read-across for trading results in the quarter,” said KBW analyst Brian Kleinhanzl. “We believe FICC (fixed income, commodities and currencies) trading should be a positive read-across to Goldman Sachs and Morgan Stanley.”
U.S. bank stocks had underperformed in recent months as economists and investors fixated on a flattening yield curve, normally the precursor to a recession. Bank executives have downplayed those concerns, pointing to continuing loan growth in the first quarter of 2019.
Brushing aside global economic concerns such as Brexit and U.S.-China trade tensions, JPMorgan’s Dimon said the U.S. economy “continues to grow, employment and wages are going up, inflation is moderate, financial markets are healthy and consumer and business confidence remains strong.”
The stock now appears to be breaking above resistance.
A Trade for Short Term Bulls
As with the ownership of any stock, buying JPM could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for JPM
Every day, we scan the markets looking for trades that JPM low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For JPM, the June 21 options allow a trader to gain exposure to the stock.
A June 21 $115 call option can be bought for about $3.05 and the June 21 $120 call could be sold for about $1.10. This trade would cost $1.95 to open, or $195 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $195
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in JPM the maximum gain is $3.05 ($120 – $115 = $5; $5 – $1.95 = $3.05). This represents $305 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $195 to open this trade.
That is a potential gain of about 156% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.