GS: Goldman Left for Dead? Low Premium Bullish Structure w/ 8 to 1 Payout if the Stock Can get Back to Book Value By Oct Expiration

by Dan August 29, 2011 8:48 am • Commentary

Update 9;50am: I paid 1.30 for this Call Fly when stock was below 113.

Over the past month as the stocks of most large U.S. money center bank and brokerage stocks got creamed, some managements stuck to the only crisis playbook they knew (that of 2008/2009), and got out in front of investors and the media, trying to calm the animal spirits, while also making statements that might come to bite them in the very asses they were trying to save in the near future.

One such firm that kept their mouth shut throughout our little summer “Crash” was Goldman Sachs…..I believe there are two possible reasons; 1st things are as bad as they seem so why say or do anything publicly that will just make matters worse and give investors, Wall Street analysts and/or the media a look at that their PR plan.   Or, 2nd, they are navigating the mine fields as they usually do with the company and shareholder’s best interest in mind, conservatively but opportunistically.  

During my career, dating back to 1997, GS has routinely demonstrated themselves in almost every market crisis to display better internal risk controls than their competitors and I can’t imagine this time was too different.  With a little more than a month left in Q3 their is ample time to make up for weak trading volumes and likely weaker investment banking activity, if in fact they were able to navigate the storm without substantial trading loses.  Wall Street estimates have been coming down dramatically all year for the banks, as recent as last week when Merrill Lynch again lowered GS estimates for Q3 on weaker trading revenues.  When the company reported disappointing results for Q2, it was implied that similar under-performance could exist if the perceived market opportunities offered a continued poor risk/reward.  If, as the company has stated they will under-perform in the near-term on risk-on days, and out-perform on risk-off days, I wonder where you would prefer to put your money in this environment… that is if you have to be invested in bank stocks?

Ok, I’ll get off their jock, but I guess the point is that with the stock down 33% ytd and 20% in the last month alone and tangible book value at about $137, I want to look for a low premium defined risk way to play a move back to the breakdown level in July of approximately $130, and getting the stock back above rock bottom valuation levels……chart below shows this key support level where until things really went haywire in early August, the stock had successfully held during the previous sell-off in May/June.

[caption id="attachment_4389" align="aligncenter" width="300" caption="2011 ytd GS Chart from Bloomberg"][/caption]


 TRADE:  GS (~$112*) BUY Oct 125/135/145 Call Fly for ~1.20

-Buy 1 Oct 125 call for 2.85

-Sell 2 Oct 135 calls at 1.90 (.95 each)

-Buy 1 Oct 145 call for .35

Break-Even on Oct Expiration:

Profits: btwn 126.20 and 135 make up to 8.80, at 135 make full 8.80, btwn 135 and 143.80 profits trail off….

Losses: below 125 and above 145 lose full 1.20 in premium paid or about 1% of the underlying, btwn 125 and 126.20 lose up to 1.20 and btwn 143.80 and 145 lose up to 1.20.


TRADE RATIONALE:  Stock is depressed and has failed to rally on good news, at the money implied 30 day volatility remains elevated at about 50 vs the 30 day historical of about 52 and 60 day of about 40.  This structure should take advantage of vol settling in the name while also offering a more than 8 to 1 pay-out if the stock was able to rally back to its previous support level and a valuation level that many with calmer heads could see as an easy target in the near term.  I chose Oct expiration as it should capture the Q3 earnings announcement that could serve as a positive catalyst.

I guess the main point about this trade is that if I am wrong, and GS was quiet because they had good reason to be and their business model is truly broken as some bears on the name suggest, then I am risking very little to make this play at what could be a near-term low from an extremely oversold condition.

* stock is up 1% in the pre-market, I will look to find a risk-reward relationship that I find attractive as the one that I laid out based on Friday’s closing prices, which could cause me to change strikes……I would probably pay up to 1.50 for this call fly.