Bank Stocks Showing Relative Strength, For Now…..Buy April Put Spreads To Express Short-Term Bearish View

by Dan March 7, 2011 6:52 pm • Commentary

[private][private]The XLF which is the actively traded ETF that tracks the S&P financial sector including many large banks and brokers has shown very nice relative strength in the last couple weeks since volatility in the market has picked up.

I am starting to look at some of the components to identify a possible bearish trade into Q1 earnings season that will start in early to mid April….Last week Merrill Lynch Downgraded GS and lowered earnings estimates for the 1st qtr. fairly significantly, going from 5.39 to 3.91 per share, and I havn’t seen cuts like this in GS on their core business since 2009 (last spring after the SEC investigation the company faced many revisions primarily to due with potential settlements and potential future liabilities).  While the cuts are significant the analyst doesn’t offer very strong reasons for the cut outside of what most know about general slow trading activity and geopolitical risk in the middle east.  But the stock reacted and broke a key support level.


-chart below shows GS breaking down (red line) while the XLF (yellow line) holds its ground, although volatility bands clearly widening for both.

-with a market leader like GS leading the way i would look for some of the weaker players to follow suit and drag the sector down a bit as we head into earnings season.  more banks will follow Merill’s lead and lower numbers on the whole sector into the qtr, and this will wear on the group.

TRADE: Buy short term XLF Put Spreads to Benefit From Impending Financial Sector Weakness….Buy Apr 16/15 PS for .23

-Buy the Apr 16 Put for .36 and

-Sell the Apr 15 Put at .13

Break-Evens on Apr Expiration:

Upside: btwn 15.77 and 16 lose up to .23, above 16 lose all .23 in premium you paid.

Downside: btwn 15.77 and 15 make up to .77, below 15 you make .77 (or more than 3x you money)

**Most banks and brokers haven’t set their reporting dates but I would fully expect them to straddle Apr expiration. If you want to choose an expiration that will encompass most than you will have to look to May, but my trade in Apr is more to catch downward earnings revisions prior to earnings reports and what I expect to be a weak market over the next few weeks.[/private][/private]