Trader Sets Up Vertical Spread Trades on JP Morgan (JPM)

12/11/2009 12:01 am EST


Beth Gaston Moon

, Schaeffer's Investment Research, Inc.

An investor expressed moderate bullishness in JP Morgan (JPM) this week, buying the January 2011 45/65 LEAPS ratio vertical call spread. This notable options activity transpired while JP Morgan’s CEO was presenting at the Goldman Sachs US Financial Services Conference. Jamie Dimon announced plans to expand by hiring up to 4,000 employees and opening 120 new branch locations. The bank’s leader also noted that the commercial bank has done “exceptionally well.” Loan demand, however, remains weak, and net interest from mortgage lending is expected to drop $1 billion next year.

As this presentation was taking place, one large-scale options trader zeroed in on the January 2011 45 and 65 calls. At 2:46 pm eastern time yesterday, two 3,000-contract blocks of the 45 calls hit the tape, one trading at $4.55 and one for $4.60. Both went off close to the ask price, suggesting they were likely executed by buyers. At the same time, two 6,000-contract blocks changed hands on the 65 calls, going off near the bid price at 70 cents per contract.

It is apparent that these investors sold two 65-strike calls (out of the money by almost 60%) in order to finance the purchase of every one 45-strike call (out of the money by just 9%). The spread was purchased for a net price of $3.175 per spread.

The 45-strike LEAPS call closed the session at $4.48, while the 65-strike call closed at 70 cents. JPM shares finished four cents lower on the day at $41.21.

Maximum risk for a ratio vertical call spread is limited to the downside by the debit paid. To the upside, however, risk is theoretically unlimited, due to the uncovered sold call at the 65 strike. The break-even prices for this particular trade are $48.175 and $81.825.

Click to Enlarge

Maximum profit is capped at $16.825, or the difference between strike prices less the debit paid to trade the spread. The investor will bank this maximum profit if JPM closes right at 65 at January 2011 expiration. At this point, the sold calls expire worthless and the investor keeps all intrinsic value in the January 45-strike call.

By Beth Gaston Moon, senior editor for the Options News Network (

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