The biggest U.S. bank by assets has already disclosed $2 billion of paper losses, and Chief Executive Jamie Dimon said it could lose another $1 billion or more.

The losses will grow, some traders say, because it appears JPMorgan has only sold a small portion of its position, leaving it vulnerable to price swings in a thinly traded market. Others are not so sure the bank will suffer much more than it already has. Dimon said the bank won't rashly sell, and any additional losses could arise throughout the year. A JPMorgan spokeswoman declined comment.

The source of JPMorgan's problems is an obscure group of indexes that track the performance of corporate bonds. One of the indexes, the Markit CDX NA IG Series 9 maturing in 2017, is essentially a portfolio of credit default swaps - basically contracts that protect against default by a borrower.

This particular index is tied to the credit quality of 121 North American investment-grade bond issuers, including such names as Kraft Foods (KFT.N) and Wal-Mart Stores (WMT.N).

JPMorgan used that index, and others, to bet that credit markets would strengthen. Because that position is widely known on Wall Street, many traders are betting the opposite way in the hope of profiting as the bank's losses increase. The index has been moving against JPMorgan in recent days.

Oppenheimer & Co used the average of the index in 2011 - 141 - to estimate on a straight line basis a theoretical additional loss for the bank of $5.9 billion. Oppenheimer analysts, however, cautioned that such a large loss was unlikely. "We think the number will be less" than a $5 billion estimate, they said.

For starters, they said, JPMorgan likely offset the trading position before announcing the loss. Their analysis also reflects a trade in a vacuum without any counter-bets. Additionally, credit quality has been improving so "the underlying market has moved in JPM's favor," they said.

Some analysts are frustrated at how difficult it is to determine the source of the bank's losses. "I've been through this exercise a few times, and I can't make the numbers make sense," said Michael Johnson, chief market strategist at brokerage M.S. Howells, who helped put together earlier versions of the credit derivatives index.

The Markit CDX NA IG 9 index maturing in 2017 stood at 128 on May 10, just before Dimon announced the losses, up from 112 at end-March, according to Markit. Higher values for the index indicate the market sees credit quality as having deteriorated, which hurts JPMorgan. On May 11, the index jumped to 139, and on Wednesday, it traded near 150.

Without knowing the specific details of JPMorgan's trades, precise figures for the bank's losses are hard to determine. The total size of JPMorgan's bets and the dates and prices it paid to place the bets are not known. It's also not known what trades the bank has made to counteract the losses.

What's more, the current higher value of the index may entice hedge funds and other investors to sell credit protection on the index, which amounts to buying exposure to the portfolio of credits. If that happens it could help JPMorgan by moving the index level lower.

WHALE SPOTTING

JPMorgan's trades are based on credit derivative indexes conceived by JPMorgan and Morgan Stanley (MS.N) a decade ago to allow banks, hedge funds and corporate treasury departments to buy and sell insurance against the risk that corporate bonds they own might default.

JPMorgan sold credit insurance on the CDX index maturing in 2017 as a way of gaining exposure to the portfolio of credits, according to traders. On its own, that position would perform well if credit quality improves or stays more or less the same.

The traders don't know JPMorgan's precise trading positions but believe they can at least partially identify them given that the index is traded relatively infrequently and given the size of JPMorgan's presence in it. JPMorgan was such a significant player in the CDX NA IG 9 index that one of its traders, Bruno Iksil, was dubbed the "London whale" in the markets.

"When someone is that big in the market, anonymity really goes out the window," a New York-based debt trader said.

The bank is believed to have had offsetting bets to the same index maturing at the end of this year. Put together properly, the combination of selling default protection on the 2017 index and buying protection on the 2012 index would protect the bank against massive weakening in the credit market.

In addition, the bank is also believed to have made bets that a high-yield index would rise - that is, that high-yield debt would deteriorate - and an investment-grade index would fall or stay stable, traders said. This trade is also widely believed to have generated losses, according to the traders, though again they can't say with any certainty.

A key job for the bank's Chief Investment Office - which oversaw the index trading - was to hedge the bank against risks of default. As one of the world's biggest lenders, JPMorgan has hundreds of billions of dollars of exposure to credit, so it makes sense for the bank to hedge against the credit market doing poorly. The bank's hedge position is believed to have been crafted to generate few changes in value if the credit markets barely budged.

INCREASINGLY COSTLY

Over time, though, keeping the trade as a bet on the market turning down would have become prohibitively expensive, because as the 2012 index got closer to expiration it would offer less of a hedge against movements in the 2017 position. If the bank wanted to keep the trade hedged effectively it would have had to buy more and more of the 2012 credit default protection.

So, by January, JPMorgan faced a decision, according to credit derivatives traders: either reduce the size of its overall trade, or allow it to turn into more of an outright bet on credit markets improving.

JPMorgan opted to allow its protection against disaster to turn into a bet on markets improving, traders said.

There may have been merit to that decision initially.

In January, investors began to have a more optimistic view of the global economy, thanks in part to the European Central Bank's decision in December to give European banks cheap access to 489 billion euros ($623 billion) of financing. The ECB followed in February with another 529 billion euros of funding.

For a time that flood of money eased investor concern about the European debt crisis - and bolstered the view that corporations would be able to pay off their debt. Signs of strength in the U.S. economy and job market helped, too.

The corporate credit index began falling, a sign of credit fears abating. In October, the index hit 182, meaning it cost $182,000 to insure against $10 million of default through December 2017. By January, the index had fallen to as low as 121. In late March, the index hit 106. Those declines likely translated to healthy gains in the first quarter.

But in April and May, the indexes began rising as investors grew concerned about the durability of a recovery. The weakening credit market likely resulted in increasing losses for JPMorgan.

Matters worsened for the bank as hedge funds began betting against JPMorgan. That pushed up the index, giving the bank more losses. In the first nine days of May, the index climbed. On the 10th day, the bank stunned markets by announcing it had racked up more than $2 billion in losses.

($1 = 0.7849 euros)

(By Dan Wilchins and Carrick Mollenkamp in New York; Editing By Alwyn Scott, Martin Howell and Ian Geoghegan)

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