JPMorgan Chase is set to report earnings on Friday before the opening bell, with an expected move of around 5.4%.
JPM stock is below the 21-, 50- and 200-day moving averages and has declined following each of the last six earnings announcements.
Let's analyze how we can structure an option trade 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 more likely to be negative.
JPMorgan Expected To Move 5.4% On Earnings
Taking the at-the-money put and call for the Oct. 14 expiration, we see that the expected range is 5.4%.
Now that we know the expected range, let's find a bear call spread with a short strike around 5.4% above the stock price.
Selling the Oct. 14, 111-strike call and buying the 116 call would create a bear call spread.
This spread was trading for around $0.70 on Friday. That means a trader selling this spread would receive $70 in option premium with a maximum risk of $430.
That represents a 16.28% return on risk between now and Oct. 14 if JPM stock remains below 111.
If JPM closes above 116 on the expiration date, the trade loses the full $430.
The break-even point for the bear call spread is 111.70, which is calculated as 111 plus the 0.70 option premium per contract.
Little Room For Adjustment
There is little room for adjustment with short-term trades such as this held over earnings. Short-term trades also contain assignment risk.
A 16% return in a few days would be nice, but the possibility of losing 100% is also very real.
As such, this trading style is only for traders with high risk tolerance and appropriate position sizing should be used.
Depending on how JPM stock trades today, traders may prefer to wait for a price higher than $0.70 for the spread.
According to the IBD Stock Checkup, JPM stock is ranked No. 8 in its group and has a Composite Rating of 41, an EPS Rating of 66, and a Relative Strength Rating of 32.
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