Based on our Commentary this morning, we see Draghi’s words as just that, words. We think the stress seen in the European banking system is not likely to be fixed by words, or quick fixes to appease markets, it will take sustained policy response, which to date Euro leaders and central bankers have been unable to do.
SO we of course are focused on U.S. banks, we have a handful of shorts in the sector and want to be exposed to the ones that we feel have the most risk if markets once again this summer get panicked by Europe (C, JPM & MS). But Today’s trade is focused on GS, one of the best of breed in the Investment banking space. This trade has less to do with Europe and more to do with the earnings picture going forward for these institutions. GS CFO David Viniar said on their Q2 call that their VaR is the lowest since 2005, indicating a reduced risk appetite and general caution on the part of management, this trend is likely to continue in this environment and regardless of ECB action, this will be a challenge for U.S. banks/brokers for qtrs to come.
With the markets up on what amounts to BS in our opinion we want to look for good risk reward trades for the near term worst case (or even just bad) scenarios, even if they face tough probabilities of success like an out of the money Put FLy.
TRADE; GS ($97.40) Bought the Sept 90/80/70 Put Fly for .90
-Bought 1 Sept 90 Put for 1.99
-Sold 2 Sept 80 Puts at .68 for a total of 1.36
-Bought 1 Sept 70 Put for .27
Break-Even on Sept Expiration:
Profits btwn 89.10 and 80 of up to 9.10, max gain of 9.10 at 80, profit trails off bwtn 80 and 70.90
Losses of up to .90 btwn 89.10 and 90 and then again btwn 70.90 and 70, max loss of .90 above 90 and below 70
Trade Rationale: this trade only works if banks make new lows and European debt contagion spreads and Draghi defaults in his promise to do “whatever it takes”. THIS IS NOT A HIGH CONVICTION TRADE, BUT I LOVE THE POTENTIAL 10 TO 1 PAYOUT IN THE EVENT THAT GS MAKES NEW LOWS IN THE NEXT 2 MONTHS AND STAYS DOWN! The likelihood is that if the stock breaks 90 I will be able to make 3x my money and move on…..SO you would only put this trade on if you thought the worst of 2012 was likely to come in the next 2 months, which I do, but I am doing it in a defined risk fairly guarded way, if we go to hell in a handbasket this summer, GS will most definitely break $90, and paying less than $1 for a $10 wide Put Fly Looks very reasonable to me.
Also the bid ask is wide with all the legs so I bid inside screens and got filled, I also am taking maybe 1/4 to 1/3 of a positon at the moment, will add if market drifts a little higher. And lastly, I have often called Put Flys the sort of “Hotel California” of options trades, easy to get in, but sometimes very hard to get out, so on top of lots of commission for a 4 legged trade, if the trade doesn’t go your way, than you are likely to let expire as paying the commission on the way out to salvage premium may not be worth it. I am risking what I am willing to lose on this one.