New Trade $MS: Vol Looks Cheap Heading Into A Monster Week For Bank Earnings

by Dan January 11, 2013 3:37 pm • Commentary

Here is a quick preview of what I will be discussing tonight on Options Action on CNBC at 5pm:

MS and many of the other U.S. banks have gotten out of the gates in 2013 with some serious enthusiasm, on top of what was an eye-popping  Q4 rally in the sector.  MS is up 5.5% in 2013, after gaining 26% in 2012, most of which came in Q4.  MS in particular had plenty of excitement his week, not only did the stock match 18 month highs, the company announced 1600 lay offs in their invest-banking division (~6%), got news from regulators that the Basel III liquidity rules would be much less stringent then originally thought and would not need to be implemented as soon as originally thought, and lastly golden boy activist hedge fund manager Dan Loeb of Third Point Investments announced he took a stake in the company.

THERE SEEMS TO BE A FAIR BIT OF GOOD NEWS IN THE STOCK AT  CURRENT LEVELS.

EVENT: MS is set to report Q4 earnings on  Friday morning Jan 18th prior to the open, the options market is implying about a 4% move on earnings which is essentially in line to the 4 and 8 qtr avg moves.

MY VIEW:  I don’t have a strong view on the fundamentals, other than it is obvious to me as a market participant that investment banking was weak in the qtr just ended, and likely to remain that way at least for a couple quarters to come. Investment banks like MS do not have all the levers that money-center banks like C and JPM have to pull to increase earnings and this will likely become more and more evident if revenues do not pick up.  MS is expected to grow earnings this year 104%, while JPM’s are expected to grown 6% and C up 16%.

MY TRADE: I want to make a very simple contrarian bet that the next week’s earnings from the likes of JPM, GS, BAC, C & MS are not enough to keep the rally going in the space and look for a quick re-tracement back to unchanged levels on the year in many of the stocks.

Implied vol in many of the names I just mentioned above seems to reflect a bit of complacency that leads me to get long premium on an outright basis.   I am not looking to step in front of the tremendous momentum that the sector has seen of late but with vol where it is, and such an eventful week in front of us, I think picking a direction makes some sense, I of course chose down!

TRADE: MS ($20.20) Bought the Jan 20 Put for .40

Break-Even on Jan Expiration (next Friday):

-Profits below 19.60

-Losses of up to .40 btwn 19.60 and 20, with max loss of .40 above 20.00.

Conviction: On a quiet Friday that has seen a tight range, I initiated a quarter size position and will look to add early next week prior to some of MS’s competitors results that start on Wednesday morning. I’ll also look to spread the trade on if there is weakness in the name prior to their own report.