All We Are Saying Is Give Banks a Chance

 | Oct 11, 2017 | 5:00 PM EDT
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JPMorgan (JPM) is one of the first big names to kick off earnings season. I'll admit bank earnings are a bit of an enigma to me. There are many facets to big bank reports, with some parts mattering greatly to some traders while not mattering to other traders at all. In my experience, the reaction of the stock immediately following earnings and over the course of the next three weeks is what matters more than the headline numbers. If you are strictly a fundamental investor, there will be plenty to dig through over the weekend and I'd avoid any immediate reaction, but if you are a trader into and out of the number, there are some items to consider here. 

First, a technical glance at the stock from a weekly perspective. Why not the daily? Well, most of what matters there will be thrown out the window post-earnings, as is the case for many stocks. The weekly view provides a better perspective of investor activity rather than trader activity. We get a better view of support and resistance. 

JPM has been running higher in a rising wedge pattern that should trigger post-earnings. Initial support appears around $92 with stronger support in the $89-$90 range. I doubt either of these will be seen tomorrow, but should the market sell off in October, these would be levels to watch for entry, especially $90. Should that fail, then $82 comes into play. Again, nothing I expect in the short term, but just a major support level to keep in the back of your mind. It's held strong for a year, so I'd put that as a worst-case scenario if the market seriously corrected.

The natural upside target is $100. First off, it's a round number, which is a psychological target for the human traders left among us. Second, it's a fairly close match to the measured upside target of this wedge. That would be my post-earnings expectations for an intraday high and something we'd test again over the next three weeks. Secondary indicators support the bull, but there's nothing that screams "buy." The setup is more "hold" if you are already long rather than take a new position here. 

The historical analysis on JPM is intriguing. The black line chart outlines the post-earnings initial moves: open, maximum intraday move and close. The glowing yellow lines are the expiration for the move this week based on the weekly option prices. As you can see, the white maximum line has hit or exceeded the current expectations every time for the past two years. In contrast, the closing levels of JPM have only exceeded that level twice in the past two years. In other words, if you are long volatility, then you better have an intraday trading plan.

My approach if I were long weekly straddles or volatility would be to sell one-third of my position at breakeven, one-third on a move of 2.5% in the underlying, and then setting a close trail on the final third at 2.75% to 3% with a hard stop at my breakeven mark, but a trailing stop that should prevent that breakeven level from being hit while still holding. This seems like a no-brainer when one initially examines the history of the stock, but it's important to note volatility has waned over the past year. The maximum intraday move over the past year have only inched above the implied weekly move for this earnings report; therefore, I would refrain from being overly aggressive with this strategy into tomorrow morning. 

Given the major support around $90 and the additional support at $92, another consideration for traders is to use the elevated implied volatility (IV) to sell something like the Nov. 10 $92.5 put around $0.57. This put is trading at an 18.40 implied volatility, about 20% higher than the 30-day historical volatility of 15.3. We can expect the Nov. 10 IV to drop after earnings as the market removes the earnings catalyst from pricing. Should the short options be put to a trader, that would mean acquiring the stock with an average cost basis of $91.93, an attractive area on the charts.

With only a month until expiration, this is an attractive risk-reward setup. While it may not feel like a big win to earn $57 against $9,193 in risk, it does equate to a 7.5% annualized rate of return and has a high probability of success. If not successful, then the result would be purchasing 100 shares of JPM at a level I would target for an initial long position anyhow. 

The "Higher/Lower" spark chart under the data portion of the chart highlights the consistency of JPM post-earnings. The stock has opened higher 75% of the time, experienced a maximum intraday move higher rather than lower 75% of the time, and traded higher three weeks after earnings 75% of the time. While the average closing move has been 1.59% nominally (not directionally), a bit of the thorns of the long volatility show up for traders. Combining these closing stats with the spark charts seems to favor more of a buy-write strategy for traders or long call spread with short put spread strategy.

For instance, buying the Oct. 13 $94-$97 call spread and selling the Oct. 13 $95-$93 put spread would cost traders around $1.78. This setup would be profitable above $95.78, about 0.75% lower than the current price. The maximum reward is $122 against $378 in risk; however, the probability of success plays in well with the averages as this trade would have broken even or made a profit seven of the past eight reports. 

As with any name into earnings, there are multiple approaches, but these are what I view as the optimal approaches based on historical data, current option pricing and the current technical setup for JPM. 

JPMorgan (JPM) -- Regression Analysis

(This commentary originally appeared on Real Money Pro at 2:42 p.m. ET today. Click here to learn about this dynamic market information service for active traders.)

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