Option Watch: JP Morgan Chase Earnings Preview

Chris Tyler, Optionetics.com
April 12, 2011

Dow component and financial giant JP Morgan Chase (JPM) reports before the opening bell Wednesday. Analysts see earnings growth of 55% on profits of $1.15 vs. last year’s $0.74 per share. Revenues are expected to fall by about 6% on sales of $25.27B compared to last year’s first quarter rake of $26.92B.

Technically speaking and as of Monday night, the banking giant is trying to handle its somewhat ubiquitous these days, V-shaped corrective base of about 10% in depth; a bit better by putting together a few days of backing and filling with its 10SMA acting as support. Bulls looking optimistically higher also have a recent 10/30SMA crossover and EW4 EBOT signal acting as support and prices still a ways from hitting Profit Source’s mid TAPP near $52 a share by June.

Additionally, the idea of a bullish sector rotation might be appreciated. Shares of JPM and the rest of the financials (XLF, BAC, WFC and GS) have severely lagged the broader market since late last April and following the subsequent Flash Crash in early May. Whereas the likes of the SP-500 has long since cleared that key technical resistance, JPM’s current base has developed as a test of those former highs.

Figure 1: JP Morgan Chase (JPM) Daily

Looking at the recent history of JPM’s immediate post earnings reaction and the general takeaway is the action has been a very mixed affair as far as volatility and direction are concerned. The last two years of reactions has produced some decent sized intraday range activity in the eyeballed neighborhood of 4%, but typically share prices have been more subdued by the closing bell with half of those days registering less than +/- 1.50%.

Of possible interest, just one earnings reaction, April 14 of last year, saw a change in excess of 4%. That session’s bullish gap and thrust reaction of 4.05% also marked the eve of JPM’s intermediate highs of the last couple years and resistance for our current base’s development.

Figure 2: JP Morgan Chase (JPM) Volatility View

So, how are option traders preparing? During Monday’s session, trading was brisk as daily contract volume picked up to a bit more than two times its daily average on 144,000. At the same time, puts saw a large spike in activity with a put/call reading of 2.00 compared to an average reading of about 0.80.

Monday’s favor towards puts coupled with a jump in already high premiums to 38% IV for the at-the-money contract suggests investors were, as a group, buying protection in front of the report or possibly just making naked bets on a bearish move in shares. Most active by a fairly wide margin, the slightly out-of-the-money April 46 put saw volume of nearly 30,000, marking a near double of its existing open interest.

With statistical volatility in the mid teens to low 20s, implieds near 40% are apt to get crushed into the mid to high 20s. At the same time though, with a current price of just $0.42 per contract and three days of trading following the earnings event, the real arbiter of value will be first and foremost the reaction in shares and theta or time decay.

Naked long ownership of the April 46 put will require a move just under 4% in order to realize a double at expiration. Taken against the historical context of recent described moves and that’s a slightly stiff request. Further, due to the timing so close to expiration and due to negative theta, that percentage amount for bears, won’t be improved upon by very much prior to that day.

On the other hand, implieds for the JPM and the broader market are near two year lows and possibly due for a trend change or at least a slight ruffling of the bulls' confident ways. Also, seeing how far both have come in terms of shareholder value since the nadir of the March 2009 bottom; maybe recent history and the current trend is a bit less telling or trustworthy?

Looking at straddle values for the ATM April 47 straddle and the pricing is a similar story. Traders are theoretically pricing in a 1 SD or 68% chance for a move, up or down of about +/- 4% through expiration using a volatility calculation on 38% implied volatility and 4 calendar days.

The estimated move means more theoretical / delta neutral traders are expecting JPM to be contained within a range of 45 and 48.75. This compares to the less active and hedge sensitive outright dollar price tag of $1.50 per straddle and breakevens of 45.50 and 48.50 or required move of about 2.8% to 3.5% or an averaged +/- 3.2%. So, who will be proved right in the days ahead? Time will tell, but this is one situation where a guy that often enough likes to have a definitive opinion; isn’t sure whether other traders in hindsight will be saying “JP Morgan & Chase!” or “JP Morgan & Do Not Chase!”

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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