Beware of the Snake in the Grass
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- Published on Monday, 25 June 2012 09:00
- Written by Sara Nunnally, Editor, Macro Trader
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A quick update... The dog that we had to take to the vet last week is doing fine. Our brood is back to normal, chasing birds and finding garden snakes in the backyard.
Our cattle dog puppy, Ruthie, was barking her head off in the flower bed yesterday evening. When I called her away, I saw the small, curled-up body. I thought it was dead, but when I went to get something to clean it up with, it slithered away.
Creepy, and not unlike what's been happening with JPMorgan (JPM:NYSE).
I recommended put options on this bank to my Macro Trader subscribers a couple of weeks ago. CEO Jamie Dimon was headed to Washington to supposedly give a good account of what went wrong when his CIO (chief investment office) unit lost at least $2 billion in a badly botched trade.
Here was my take:
The Volker Rule, which is meant to prevent the big losses that JPM will have this quarter, could be a step to even bigger changes.
The Volker Rule says that regulated commercial banks insured with government money cannot engage in proprietary trading, unless through a specific plan meant as a part of liability management. Derivatives and high-risk strategies are also a no-no under the Volker Rule.
For JPM, which raked in $19 billion before its $2 billion (or more) loss, that figure is grossly more than what's expected from a risk-hedging strategy... especially from a commercial bank.
That industry hasn't been very profitable lately.
The obvious -- if not 100% proven -- answer is that JPM was trading like a hedge fund. A clear violation of the Volker Rule... the cost of which has yet to be determined. The company canceled a $15 billion share buyback program, and investors have lost 25% of their shares' value in the past five weeks alone.
But rather than the tongue-lashing I was expecting, folks on the Senate Banking Committee actually apologized to Mr. Dimon!
The "Ruthie Alarm Barks" went off the minute the big losses were announced. The $2 billion figure wasn't anything close to what Mr. Dimon told investors the CIO unit trade would lose when he spoke to them at the first-quarter earnings call.
Instead, Mr. Dimon was contrite, taking full responsibility for the losses, without damning the practice of what's clearly proprietary trading within an office that's supposed to be managing risk and liabilities.
Under the upcoming Volker Rule, that kind of trading will not be allowed.
Dimon's charm worked... but what most investors are forgetting is that the snake's still in the grass.
JPMorgan's share price climbed from $33.07 to just under $37 per share before dropping away again. I'd told my Macro Trader subscribers to use a stop loss if the stock closes at or above $37 as an exit point for the put options, and we're barely scraping by with that level.
JPM has reported that between 65% and 70% of the CIO trades that racked up at least $2 billion in losses have been unwound.
But that didn't stop Moody's from downgrading JPM's debt, along with that of 14 other banks, last Thursday. On the news, JPM traded back down below $36 per share.
Then came the bounce back on Friday.
Moody's classified JPM a bit differently than other banks, saying it had strong buffers against other financial stress.
Which is true. JPM has one of the most diversified business models in the banking industry. But that still doesn't account for the possible restructuring of how JPM trades through its CIO unit once the Volker Rule comes into effect...
... in just a few short weeks.
Friday morning, JPM jumped 2.5% in the first hour of trading.
My Macro Trader play could very well be stopped out on this move, but I'm not convinced that JPM or any of the other banks are in the clear yet.
Here's an updated version of the chart I showed my readers earlier this month:
This is a double-top formation that has the potential to break below that bottom red line. That would put JPM at $28.48, just for starters. The orange line is our stop-out level, and you can see that we are toeing that line.
If markets fall and/or there's more bad news out of Europe, I expect JPM to drop back from this level quite quickly.
If we can stay in this play long enough, my Macro Traders could be in for some nice profits on the move lower.
Happy Investing,
Sara
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