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There's Always a Bigger Fish
Issue // March 21, 2023
UPDATE
Spring or Winter? Can’t Have Both
By The MARK IT. Team
🌤️ Good morning, and happy Tuesday. Yesterday was the official start of spring when the spring equinox happened. Last week, many states had cold fronts and freeze warnings that dashed spring break plans. Now, we hope you can begin to enjoy the warmer weather in the coming weeks.
This week is also when Ramadan starts, the holy month of fasting for Muslims globally; this means no food or drink from sunrise to sunset, which could be longer or shorter depending on where you live.
We hope you enjoy this week’s issue, have a great rest of your week.
WEEK IN REVIEW
Banking System Strategy
By Abbas Akhtar
Following the collapse of Silicon Valley Bank (or SVB) two weeks ago, several other U.S. banks began to show signs of weakening financial health. In last week’s issue, Hero to Zero, we reported how many of SVB’s issues stemmed from losing trades and interest rate problems with treasury bonds. The other banks mentioned this week seem to have different reasons for failing.
Signature Bank, headquartered in New York City, seemed to have limited exposure to the SVB collapse. However, depositors began to worry about possible links in the aftermath of SVB’s collapse, which prompted many to withdraw their funds. News of this dropped the stock down around 30% before being de-listed. There were also concerns about Signature’s exposure to the crypto market as a lending tactic after the crypto market imploded last fall. Sources: Bankrate, npr
Another bank at risk is First Republic Bank, based in San Francisco. Though the bank hasn’t failed at the time of reporting, there are similar liquidity fears as the ones that prompted the bank run on SVB. Many depositors at First Republic are worried about the bank’s lack of on-hand finances. This concern is reflected in the stock price, which has dropped approximately 90% since March 8. These fears ultimately caused eleven big banks, led by JP Morgan, to inject over $30B into the bank to assure depositors they could be repaid. Source: New York Times
WEEKLY WATCHLIST
A Giant
This week, we're reporting on one stock which we see as a sturdy company in the financial sector.
STOCK #1
JP Morgan Chase & Co (JPM)
As noted above, we’ve seen JP Morgan take the lead in keeping banks afloat. Being the largest U.S. bank, JP Morgan is well-positioned to help smaller banks when needed while having plenty of liquidity for its depositors.
We previously reported on JP Morgan but given a slight decrease in the stock price due to general bank sector fears, we believe this stock might attract value investor attention.
JPM Stock (6-month), via Google Finance
⚠️ Inconsistent cash flows: Since 2009, the free cash flows of JP Morgan have been choppy. Each year brings a sharp rise, followed by a sharp fall. This trend could make value investors uneasy.
✅ Healthy dividend: With a 3.15% dividend yield, JPM’s divined is higher than the average yield.
✅ Undervalued according to DCF: Based on our discounted cash flow model, a single JPM stock at Monday’s market close price of $127.14 is between 35-40% undervalued.
⚠️ Higher debt: Of the total Enterprise Value (EV) of JPM, debt is approximately 46% (339.9B) compared to a market cap of 54% (388.9B).
MARK IT. EXPLAINED
What Are Options? (A Deeper Dive Into Hedging)
By Mario Montero-Ruberu
Stock options have been around for a long time, first introduced by the Chicago Board of Mercantile Exchange in 1968. Stock options commonly referred to as options, provide investors with the explicit right, but not obligation, to buy or sell 100 shares of stock at a predetermined price before a given date. This “right but not obligation” describes an options contract. Options have historically been used as hedging instruments, reducing the risk of adverse movements in long or short equity positions. For example, if I bought 100 shares of Apple at $150 but they fell to $135, wouldn’t it be helpful to have the right to sell them at $150, even though that’s not where they're trading? That’s where options can help. Read our Slow and Steady issue for a full piece on hedging.
While many option types are available, the two most popular are long calls and long puts. A long call provides the right to buy 100 shares at a set price before a given date, and a long put provides the right to sell 100 shares. In the Apple example, I mentioned a long put option. I have the right, but not the obligation, to sell my Apple shares at $150 before a given date. That $150 is referred to as the strike price—the explicit price one can buy at with calls or sell at with puts. Remember that “before a certain date” I mentioned? Unlike common stock, options cannot be held forever; options have expiration dates or a limitation on how long an investor can hold them. For stocks, options can have expiration dates ranging from one week to multiple years. What happens at expiration? If an investor hasn’t exercised their option to buy or sell their shares at the strike price (our predetermined price mentioned above) one of two events will occur. For a call, the option to buy 100 shares will be automatically exercised by the broker if the stock trades above the strike price. If it doesn’t trade above the strike price, the option is worthless! The flip side is true for a put, the option to sell 100 shares will be exercised if the stock trades below the strike price; if not, the option is worthless! In many cases, options are never exercised, and investors sell the option contract at a gain or loss.
Since options can only be held for a limited period and induce the risk of losing an entire investment, stock options are inherently much riskier than common equities. The increased volatility experienced by indices such as the S&P 500 in recent years has invited some retail and institutional investors to purely trade options for gains in contract prices. This is, however, extremely difficult to execute and requires high-risk tolerance. For investors with large holdings of common stock, though, the risk is substantially lessened if they’re holding options to hedge their shares.
Options can be lucrative, but are extremely risky! Be sure to do your due diligence and examine your risk tolerance before considering the use of options for hedging or speculative purposes. Sources: Investopedia, Reuters
ONE MORE THING
Keep in Touch
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