Trade Update WFC: Defining Risk in Losing Trade

by Dan October 2, 2012 1:52 pm • Commentary

Trade Update Oct 2nd 2012 at 1:52pm:  A few weeks back, after the ECB and the U.S. Fed were done eviscerating the shorts (me included), I was looking to find some perceived low risk longs that would benefit from the latest round of QE offered by the central bank.  While I conceded that “Fighting the Fed” was likely to be be fruitless endeavor for the balance of the year, I was still holding on to a handful of my consumer/China focused short bets.

As detailed below, I did something in WFC that I have not done for a long time on the site, sold puts naked to buy calls (a risk reversal).  For much of our directionally biased trades we generally chose to define our risk with long premium structures.  IN this moment I made a bad decision and one that I am not panicked about, but it bugs me none the less.  I sold a Put on a stock at 52 week highs with relatively low volatility.  If one of my panelist friends on Options Action had suggested this trade, 9.9 times out of 10 I would have disagreed with the structure, I can’t remember, but I think they were kind to me.

Since executing this trade on Sept 14th, WFC is down about 3.7% (ugh) and the Jan 33 Put that I sold at .85 is now worth ~1.05, and the Jan 38 call that I bought for .90 is worth only .40.  I am down .70 on the trade and frankly don’t feel comfortable staying short the Jan 33 Put.  I am going to cut my loses on the Put portion, and stay long the Call, now doing what I should have done Sept 14th, define my risk.


Action: Buy to Close WFC ($34.70) Jan13 33 Put for 1.07, locking in at least .22 loss.
New Position; Long WFC ($34.70) Jan13 38 Calls for essentially .72 (.22 loss from the puts, the .50 loss of the calls), Break-even now 38.72 on Jan13 Expiration.





Original Post Sept 14th, 2012: WFC: The Fix Is In

Here is a quick summary of the trade that I will be detailing tonight on Options Action on CNBC at 5pm:

This is a bit of an obvious trade, but of all of the large banks, WFC could quite possibly be the largest beneficiary of the FOMC’s latest round of bond purchases given there large exposure to mortgages.

-Technically the chart has been a monster all year as many of it’s money-center bank cousins experienced severe highs and lows.  Heading into yesterday’s Fed meeting the stock was already up ~25% ytd and this week breaking out to levels not seen since late 2008.

5 yr WFC chart from Bloomberg


The chart is a monster, but with such a low beta I am not expecting 20% move in a straight-line, this will likely notch higher with strong market, and likely be considered defensive by investors on a move lower given it’s healthy 2.6% dividend yield.

At this point I am just gonna close my eyes and get long.  This Rather than buy the stock though I am going to sell a put to finance the purchase of a call as I don’t see a ton of risk in being short Puts in this name, even with implied vol relatively low.

Trade: WFC ($36.04) Bought Jan 33 / 38 Risk Reversal for .05

-Sold 1 Jan 33 Put at .85
-Bought 1 Jan 38 Call for .90

Break-Even On Jan Expiration:

-Profits above 38.05(up 5.5%)
-Losses below 33.05 (down 8%)

-Btwn 38 and and 33 lose .05, below 33 I am put the stock.

-Structure has about a 60 delta, so on a mark to market basis prior to expiration if stock moves down a dollar I will lose .60, if the stock goes up a buck i make .60, delta will increase as stock goes higher and decrease as it goes lower.