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Trading Options On Bank Stocks
Trading options on bank stocks may be more volatile than usual now that JPMorgan has admitted to $2 Billion in losses on credit default swaps. These are the same kind of vehicles that caused such substantial losses during the stock market crash of 2008. The admission by JPMorgan in an after-hours conference call brings to mind the ongoing need for regulation in the securities industry. For those trading options on bank stocks it brings to mind the need to keep close tabs on the actions of and credit worthiness of banks. Up until the news about JPMorgan concerns about trading options on bank stocks centered on questions about Euro Zone Austerity or growth. Now options traders need to be concerned about whether back room hedge fund tactics are going to sink an otherwise profitable bank. The other question is whether or not other banks are also hip deep in the same tactics and at risk for the same level of losses, or worse.
The good thing about trading options on bank stocks is that by purchasing options on these stocks the trader limits his risk. Buy a call on JPMorgan and you stand the chance of making money if the stock goes up in price. When buying a call you purchase the right to buy the stock in question at the contract or strike price and can then sell it at a new and higher price when the stock goes up. You can also simply sell the call option which is not worth more. If you buy a call option on JPMorgan and it turns out that the losses on credit default swaps are worse than anticipated you will not make money. However, you will never lose any more than the price of the options contract. More likely you will sell you the call contract at a loss prior to expiration and further limit your losses. If you expect JPMorgan stock to fall further you can purchase a put on the stock. This gives you the right to sell the stock at the contract or strike price even if the price falls dramatically lower. As with calls you can simply sell the contract which is now worth more money. And, if it turns out that JPMorgan pulls a bunny out of the proverbial hat and limits its losses on credit default swaps? Well, then you will not make any money on a fall in stock price but you will limit your losses to the price of the options contract or sell the contract and limit your losses even more. A useful way to profit if the stock goes up or down is called a long straddle. In this case you purchase both a call and a put.
Leveraging Investment Capital with Options
In trading options on bank stocks in a situation like JPMorgan’s the options trader enjoys a degree of leverage on his capital. If he buys calls and/or puts his investment is the cost of the options contract. He need never take possession of the stock in question so he does not need to come up with money to buy stock.