Eyeing An Iron Condor Set-Up On JP Morgan For Tuesday - Part 2
Yesterday I talked placing a potential iron condor on JPMorgan Chase & Co. on Tuesday. JP Morgan Chase & Co. operates as a financial services company worldwide. It operates in four segments: Consumer & Community Banking (CCB), Corporate & Investment Bank (CIB), Commercial Banking (CB), and Asset & Wealth Management (AWM).
A couple of weeks ago, the Federal Reserve performed a bank stress tests. Under the Dodd-Frank Act legislation for banks following the Great Recession, banks now go through various economic scenarios each year to determine whether they could maintain adequate capital if a severe recession were to occur. But JP Morgan feels they have enough capital to handle a severe recession and continue to pay a dividend.
But does JP Morgan really have the cash to pay a dividend shorter / longer term?
A common equity tier 1 (CET1) ratio compares a bank's capital against its risk-weighted assets to determine its ability to withstand financial distress.
Basel III is an international regulatory accord that introduced a set of reforms designed to improve the regulation, supervision, and risk management within the banking sector.
Tier 1 capital, under the Basel Accord, measures a bank's core capital. The Tier 1 capital ratio measures a bank's financial health, its core capital relative to its total risk-weighted assets (RWA). The minimum tier 1 capital ratio is 6%. A common equity tier 1 (CET1) ratio compares a bank's capital against its risk-weighted assets to determine its ability to withstand financial distress.
Here is how the CET1 ratio is set up:
The middle layer, the stress capital buffer, is new this year. It includes four quarters of common dividends and a buffer to cushion potential loan losses that could arise from the Fed's stress testing scenarios. This is why stress testing is so important, because based on what the Fed projects in its models, it has the power to make banks increase this middle layer, therefore increasing the entire CET1 ratio requirement. JPMorgan saw this piece of the equation go from 2.5% to 3.3%, resulting in the overall increase.
JPMorgan's actual CET1 ratio should rise after the second quarter, but given that the coronavirus doesn't look like it's going away until there is a vaccine, the 11.3% ratio makes a dividend cut down the line much more of a possibility.
So if I put on a iron condor with short strikes outside the yellow dashed lines, in theory it should be OK, but it wouldn't be a delta neutral trade.
Volatility skew is an options trading concept that states that option contracts for the same underlying asset—with different strike prices, but which have the same expiration—will have different implied volatility (IV). IV is the uncertainty in a stock’s option at different price level. Volatility skew is the inequality of implied volatilities of out of the money calls and puts. Volatility skew tells us the demand for those calls and puts.
In the case of JP Morgan, since the implied volatilities of out of the money puts exceed that of the out of the money calls, volatility is skewed to the downside.
Delta neutral incorporates volatility skew into strike selection. Delta Neutral attempts to minimize the adverse affect on your iron condor in order to get the most out of time decay in order to have a true "non-directional" trade.
The screen shot below was taking this morning at 9:49 AM. As you can see the out of the money puts at $85 and $90 are slightly higher than the out of the money calls at $100 and $105. This indicates the volatility skew is negative. So the there is some short delta built into the potential iron condor already.
So instead of placing a trade at the yellow dashed lines, to truly make the iron condor delta neutral initially would be to place the iron condor short strikes on the call below the upper yellow dashed line at the $102.50 level (fusia dashed line).
This post is my personal opinion. I’m not a financial advisor, this isn't financial advise. Do your own research before making investment decisions.
Posted Using LeoFinance
