JP Morgan Chase is due to report earnings on Friday before the opening bell and the options market is pricing in a 3% move in either direction. Here's how to structure an option trade that profits with JPM stock staying in its expected range with a positive bias.
Earnings are due for a number of bank stocks in the coming weeks. With earnings season also comes options opportunities.
JPM stock has stayed above the lower expected range following five of the last six earnings announcements.
We can structure a bull put spread that fits the view that 1) we think JPM stock will stay within the expected range and 2) the response to the earnings report is likely to be positive.
Knowing Your Expected Range
First, we need to know that expected range. With JPM stock trading around 147 this morning, we can take the at-the-money put and call at 147 for the July 14 expiration. That sum of 4.30 divided by the stock price gives us an expected range of 2.9%.
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Now that we know the expected range, we'll look for a bull put spread that has the short strike roughly 3%, or four points below the stock price.
Selling the July 14 put with a 143 strike while simultaneously buying the 138 put with the same expiration creates the bull put spread.
Profits And Losses For Bull Put Spread
This bull put spread traded around 50 cents this morning. As this is a credit spread, the option trader receives $50 in option premium. That's also the maximum profit.
The maximum risk takes the distance between the strikes, which is five, and subtracts the premium received for a risk of $450.
So in under a week's time, you could have an 11% return on risk if JPM stock remains above 143 at Friday's close.
If JPM stock closes below 138 on the expiration date the trade loses the full $450.
Managing The JPM Stock Option Trade
The break-even point for this bull put spread is 142.50 which is calculated as 143 less the 50 cents option premium per contract.
But there is little room for adjustment with short-term trades such as this held over earnings. Either it works or it doesn't. While an 11% return in a few days would be nice, the possibility of losing 100% is also very real.
As such, this style of trade is only for traders with a high-risk tolerance.
If JPM stocks ends below 143, long-term investors could consider taking ownership of the 100 shares and selling covered calls against it.
According to IBD Stock Checkup, JPM stock ranks No. 1 in its group. It has a Composite Rating of 95, an EPS Rating of 92 and a Relative Strength Rating of 84.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
