What we know is that it will not require a bailout – always a concern because JPM is “too big to fail” – nor will it affect depositors at the bank. It does impact JPM shareholders and will cause investors to re-think the risks associated with financial institutions generally.

This latter point is especially poignant as the “hedge” was unrelated to risks that are apparent… such as sovereign defaults across the eurozone. On the surface, this appears to be a badly executed trade initiated in London presumably to circumvent US regulations.

If that were not enough, JPM’s CEO Jamie Dimon has been leading the lobby against undue US regulations for some time. But with this misstep, even if we were to assume that Mr. Dimon’s arguments have merit, it will be politically impossible to water down any regulation that does not error on the side of caution.

Unyielding regulations will do one of two things: 1) it will cause regulators to tighten their grip on US financial institutions which dampens profitability or 2) it will cause US institutions to move more of their risk offshore which gets in the way of transparency.

The more serious problem is that a gaffe of this magnitude causes investors to paint all banks with the same brush. Regardless where they are located or what their business model is. It will likely rein in any potential upside for Canadian banks which are probably the best of the best with significantly less coverage in the credit default market and only minor exposure to the kinds of risks associated with sovereign debt.

Repairing the damage will be time consuming. There will be the inevitable full court press from politicians who are certain to use it as the rationale for government oversight. Shareholders want to know the extent of the loss – the trade is still being unwound – and then be reassured as to the checks and balances that will be put in place to prevent it from happening again.

In the meantime one could make the case that best of breed Canadian banks may benefit as institutions shift their mindset away from a bigger is better strategy. Think of it as a risk off trade that allows a manager to maintain a position within the financial sector.

While I doubt that Canadian banks will see any short-term benefit there does not appear to be much downside. What traders might consider is entering a trade to short puts as a low risk alternative that takes advantage of the twin themes: minimum downside but, for the near term, limited upside.

Toronto Dominion (TSX: TD, Friday’s close $80.51) is one Canadian bank worth considering. Specifically look at writing the July 80 puts at $2.60 or better. With the sale of the puts you are obligated to buy TD shares at $80 until the July expiry. If you end up with the shares your net cost is $77.40 ($80 strike less $2.60 premium = $77.40). If the stock does stabilize or even rise between now and July, the put will expire worthless and you will retain the premium.

If you want to hedge against further downside you could also look at buying the July 72 puts for 70 cents. Your net credit is $1.90 ($2.60 received from the sale of the July 80 put less the 70 cent cost to buy the July 72 put) but with this spread you have limited your downside to the 72 strike.

The other advantage of this spread trade is that you are able to clearly define margin requirements, which eliminates any possibility of getting a premature margin call.

The risk metrics applied to the categories seems straightforward; you buy 100 shares of XYZ and sell one XYZ call the option is covered with risk and return clearly defined. Lower risk! Sell a call when you do not own the underlying interest is uncovered and the risk is unlimited.

Categorizing risk becomes more of a challenge when dealing with put options. The covered call is considered a lower risk bullish strategy. The put equivalent strategy from a risk and return perspective is the cash secured put.

For example; you own XYZ shares at $10 and sell the September 12.50 calls at $1.00. If the stock rises you profit, if it falls you lose. The maximum risk occurs if XYZ falls to zero resulting in a $9.00 per share loss ($10 purchase price less $1 premium = $9 net cost).

Now flip it to puts. The equivalent strategy is to sell the XYZ September 12.50 puts at $3.50. Creating an equivalent position requires the investor to set aside $12.50 in cash to secure the short put. The $3.50 premium received from the sale of the put is part of the $12.50 cash security which means that the investor’s out of pocket commitment is $9 per share. The maximum risk is $9 per share which would occur if XYZ falls to zero.

Here’s the rub; the equivalent positions are categorized very differently. The covered call is a level 2 strategy while the “uncovered” cash secured put is a level 4 strategy. There is logic to the distinction when you consider that there is no way to force the investor to maintain the cash position as security for the short put.

The real issue is how the industry categorizes covered puts which is usually as a level 2 strategy. But to “cover” a short put one has to be short the underlying interest which by definition implies unlimited risk. Being short the underlying interest protects you against a scenario in which the stock declines to zero but gives rise to an unlimited risk scenario should the market go higher.

The reality is that a short put is only “covered” in terms of defining risk and return when it is part of a spread where one holds a long put that expires at the same time or after the short put. Seemingly a lower risk alternative yet spreads are considered a level 3 strategy implying higher risk.

At a time when regulators and traders are pre-occupied with risk I find it interesting that we continue to put forth guidelines that misappropriate risk metrics. For investors it becomes a confidence issue because if regulators cannot articulate the risks inherent in exchange traded instruments and strategies what chance do we have that there is appropriate oversight on the more complex over the counter versions of risk products?

Just a thought!

Trouble is, gold miners are businesses. They face costs and risks, both of which have been rising lately, putting pressure on profit margins and driving down valuations. This has become particularly noticeable since the beginning of 2012. Rising operating costs as a result of higher oil prices, higher wages, and lower ore grades have boosted cash costs for most miners. According to an RBC report, average cash costs for top tier miners in 2012 are likely to rise to US$618 per ounce from US$546 per ounce in 2011. And, says RBC, the risk is to the upside, meaning that costs could rise even more. That could put many gold miners in a tight spot for the rest of the year.

Options traders looking to leverage the possibility of continuing declines in the global gold sector might consider bearish trades in a broad index like the iShares S&P/TSX Global Gold Index (TSX: XGD, Friday’s close $19.31). Or even look at buying puts on the index as a way to hedge against further downside in gold stocks you may currently hold. With that in mind, look at buying the XGD July 19 puts at 75 cents.

For every rule, however, there is an exception. Speculative traders looking for a contrarian position might consider bullish trades in Agnico-Eagle Mines Ltd. (TSX: AEM, Fridays close: $38.70), which just reported first quarter earnings per share of $0.46, up from $0.26 a year earlier. The company reported it produced more gold in the first quarter (254,955 ounces) than in the first quarter of 2011
(252,362 ounces). Cash cost rose to $594 per ounce, up from $531. For all of 2012, the company expects to produce between 875,000 and 950,000 ounces of the yellow metal, at a cash cost of between $690 and $750 per ounce.

The company is coming off a bad year in 2011, having shut down its Goldex mine in Val D’Or, Quebec, owing to flooding and unstable rock formations. Share price was beaten down accordingly (down -46% since last September), but with mining and exploration operations in Canada, the U.S., Finland, and Mexico ramping up, 2012 could see an upside surprise for Agnico-Eagle, one that nimble options traders might turn to their advantage.

With his trade I would look at writing short-term at-the-money puts, specifically selling the AEM June 40 puts at $2.40 per share or better.

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Senior management that took its eyes off the ball while pursuing hockey teams and university research school naming rights didn’t help. Market share for the company’s iconic BlackBerry smartphone eroded sharply in the face of persistent attacks by phones carrying Google’s Android operating system and Apple’s iPhone.

And now it appears RIM is in play. The company has been actively shopping for financial advisors to help it choose “strategic options” – typically a euphemism for selling part or all of the company. JP Morgan Chase & Co. is now reported to be a front-runner.

So what happens if the company is in play? A takeover does not appear likely as we are witnessing a company with a declining subscriber base, revenue base and market share. On the other hand, RIM has a pristine balance sheet including a $1.7 billion cash hoard, but those are not necessarily attractive in a tech takeover.

What makes more sense is a licensing deal to take advantage of RIM’s still-valuable proprietary BlackBerry technology, networks, and patents. That might attract the interest of, say, Microsoft Corp. or Samsung, looking to find a way to compete with the Goliath Google Inc. and the ever-ripening Apple Corp. Mind you there are a lot of questions as to just how valuable these assets are. Considering that RIM on its own is not having much success competing with Google and Apple.

Still, if there is interest it could light a fire under RIM stock which seems to have leveled off around $13. If a bidding war erupts – which is far from certain – it could happen sooner rather than later and that would light a fire under RIM call options.

If you are interested in playing the RIM sweepstakes you can do it from two perspectives. The first strategy is to simply buy six month out-of-the-money call options to take advantage of a potential licensing deal. This strategy would appeal to the most aggressive trader looking for a short term windfall with limited risk. The RIM Sept 15 calls at $1.30 look interesting.

Another approach is an at-the-money covered call strategy. This strategy hinges on whether you believe that RIM has support at this price point and that a licensing deal is probable. If no deal surfaces, the shares of RIM will continue their downward path making it feel like death by a thousand pin pricks.

With the covered call, you would buy the shares and write the June 13 calls at $1.25. The sale of the calls provides downside protection to $12.01 per share. The in-the-money covered call would return 8.2% over eight weeks if the stock stays the same or rises. Not bad for a conservative investor who believes the short term downside is limited with the shares being supported by the notion the company is “in play.”

In order to craft a reasonable answer to this near-term question, it is usually helpful to put the current situation in its historical context and draw insights from various correlations that exist. The following diagram will help to shed light on this process:

The major fundamental events that have driven market valuations have been inserted in the above 2-year timeline. The Canadian Dollar has fluctuated in a predictable wave pattern over the period, ending where it began two years back at roughly parity with the U.S. Dollar. Here are a few insights that can be drawn from the data presented:

• Returns for the period are designated on the right-hand axis, and all comparisons have been derived from USD$-based Exchange-Traded Fund (“ETF”) values for convenience;
• Commodities, as represented by the “OIL” ETF, tend to be more volatile than stocks, which also tend to be more volatile than currencies;
• Uncertainty breeds volatility, and the negative aspects of the European debt crisis have caused severe downturns to occur in both 2010 and 2011;
• The central bank in the U.S. elected to expand the money supply from September of 2010 through June of 2011 to add liquidity to the credit markets and keep Treasury rate yields down. On an international basis, these actions weakened the U.S. Dollar, thereby strengthening the Loonie in the process;
• A broad-based economic recovery in the United States followed these easing measures and fostered valuation run ups in stocks, commodities, and currencies;
• An increase in global oil prices has stunted the current rally, as supplies attempt to catch up with demand. The Loonie is heavily correlated with oil prices, due to the nation’s export trade and wealth in known oil reserves. As a result, the Canadian Dollar pulled back slightly, offset to a degree by more export demand from the United States.

What does this mean for future prospects for the Loonie? Presently, there are more reasons supporting an uptrend at the moment than a move downwards. Although oil prices have pulled back slightly, recent analyst surveys suggest that prices could hover in the USD$110 to USD$130 range for 2012, producing upward pressure on the Canadian Dollar. Higher oil prices could also dampen the recovery in the United States, offsetting to a degree the impact that oil has on our nation’s currency.

All eyes, however, are focused on the potential of a recession in Europe and a “hard landing” in China, as it pulls back its growth engine due to lower import demand from the West. Both variables could also cause a major “bump in the road” regarding the fragile economic recovery in the U.S., which many hope would persuade Ben Bernanke and the Federal Reserve to unveil another quantitative easing program (“QE3”). More easing would lead to more strength in the Loonie.

Financial markets do not stay in a “ranging” mode forever. Sooner or later, a breakout will take place, but odds currently favor the Loonie. Only time will tell.

Tom Cleveland has accumulated over 30 years of experience in the international payments industry with the additional background of executive management, corporate governance and business development. Mr. Cleveland earned an engineering degree from Georgia Institute of Technology and did graduate work in Finance at Georgia State University. Currently, Tom writes for www.forexcharts.net and offers a lot of insight by expressing his ever-growing investment knowledge.

It’s not surprising for investors to be nervous when police pull up to the front doors of the company. According to the Montreal Gazette “within 45 minutes of the news hitting Twitter, the already battered stock had lost more than five per cent, and had fallen seven per cent before it began to bounce back. By 7 p.m. it had returned to $38.40, down $1.67, or 4.17 per cent since the start of the day.”

That the stock was able to bounce off a low should not be a big surprise. After all, apart for the optics the raid was really the continuation of an ongoing saga. In other words, more of the same!

In the end, we are talking about US $56 million of payments that an SNC internal investigation found to be suspicious and then turned over to police. The company is fully cooperating with law enforcement. If it turns out that the payoffs were to secure construction projects then the payments breeched the company’s internal code of ethics and may be illegal. The latter would be an issue for the departed executives.

The company is doing everything it can to distance itself from the rogue executives that purported to make or approve the payments. Still, until we see some closure, these allegations will hang over the company as a thickening black cloud. At the very least it will be hard to build a bullish case for the shares.

Speculative options traders might want to place bearish positions on SNC stock, in the expectation that further revelations, raids, or contract cancellations (as has already happened with the World Bank) could lead to even more loss of investor confidence and further downdrafts in share price over the short term.

The normal response to this type of trade would be to simply buy puts. However, with at-the-money options trading at a 33% implied volatility, the premiums are in the top quartile of all Canadian options. Which is to say it is expensive to buy SNC puts.

There are two approaches that bearish traders might consider; the first is a bear call credit spread the second is a bear debit put spread.

The bear call spread would involve the sale of the SNC May 40 calls at 85 cents together with the purchase of the May 44 calls at 15 cents. This trade would create a 65 cent credit in the account which would be the maximum potential profit on the position. If SNC closes below $40 per share at the May expiration, both options will expire worthless and you will retain the net premium.

The risk is that the stock rises sharply, which is why we are hedging against a sharp upside move by purchasing the SNC May 44 calls. The May 44 calls limit exposure to the upside as they will offset any losses in the May 40 calls above the $44 strike. Price.

The second strategy involves a debit spread, where you would buy the SNC May 38 put at $1.55 and sell the May 34 put at $40 cents. The net cost for the put spread is $1.15 per spread, which is the maximum you can lose on the trade. The best case scenario would see SNC decline below $34 per share by the May expiration. At $34 per share, the May 38 put would be worth $4.00 and the May 34 put would expire worthless. As such, the maximum return on this trade is $4.00 with a maximum risk of $1.15.

The reason – at least, one commonly-posited reason – officials at the US Fed are saying that another round of quantitative easing may not be necessary after all. At least it will not be likely if the US GDP continues to rise and US unemployment continues to fall.

Another factor affecting gold is demand in India. Apparently demand for gold has waned temporarily, owing to a jewelers’ strike. Not sure if that means there will be binge buying once these folks get back into gear.

In reality, gold has been drifting downwards since last fall, as the US economy continues to improve, and inflation remains contained. Speculative activity has eased, and while gold remains an attractive safe-haven asset, the investment price premium has shrunk as investors’ risk aversion wanes.

As a consequence, gold mining shares have felt the pinch, with the S&P/TSX Global Gold Index down 31% since last September. Individual mining stocks, like Barrick Gold Corp. (TSX: ABX) and Goldcorp. Inc. (TSX: G) have slid more than 25% in the same period. The index-tracking iShares S&P/TSX Global Gold Index Fund (TSX: XGD) is down 32%.

Speculative traders who believe that gold has further to fall, might opt to buy puts on the gold miners. But that might not be the best approach. I say that because mining companies have different metrics than physical gold. Of course their profits depend on the price of gold, but at these levels the big name miners (i.e. Barrick and Goldcorp) can wring out decent profits based on the margins between their costs of extraction and current prices.

At this stage, I would be more inclined to trade the miners from the bullish side with covered calls or cash secured puts. Specifically consider buying ABX at $40.51 and writing the July 42 calls at $1.80. With Goldcorp, buy the shares at $40.60 and write the July 42 calls at $2.20.

If you prefer to use puts, look at writing the Barrick July 38 puts at $1.40 or the Goldcorp July 38 puts at $1.70.

If Moody’s outlook pans out, that could spell trouble for some of Canada’s biggest paper producers, such as Domtar Corp. (TSX: UFS, Friday’s close: $95.27). Shares are trading just off their 52-week high of $102, after a powerful, uninterrupted rally since last August. Positive analyst sentiment is running exceptionally high, with consensus recommendations generally at the “strong buy” level. However, given that the company posted an 80% drop in quarterly earnings in the fourth quarter of 2011, as pulp prices fell and shipments dwindled, and given that the outlook for paper products is not good, the consensus estimates might just be a case of pulp fiction.

Going contrary to analyst expectations, Moody’s does not expect the situation to improve, suggesting further downside risk for companies in the forest products and paper sector. If you are an aggressive trader who buys into this argument consider establishing long put positions in Domtar to lever the potential of further downside. Specifically look at buying the UFS June 94 puts at $3.50.