Trade Update Jan 17th, 2012 at 11:00 am: As The WFC call calendar that I traded last week has gradually appreciated, and with one day left to expiry and the stock right at my desired $35 strike, I’m going to take my profits on this trade. I could wait the extra day to collect another 10-15 cents, but I’d be risking a 1% move in either direction, so it’s basically a flip of the coin here. I’ll take my profits and move on.
Action: Sold to Close WFC ($34.97) Jan/Feb 35 call calendar at $0.41 for $0.17 gain
-Bought 1 Jan 35 call for 0.16
-Sold 1 Feb 35 call at 0.57
Original Trade, Jan 10th, 2013:
Since I wrote the WFC Earnings Preview yesterday (below), the implied move in the stock has inched higher from about 3% up to almost 3.5%. While that’s a small difference, I became more intrigued when I looked at Feb implied vol in WFC at 20, which is historically cheap, and only has a few points of downside from here.
I expect WFC to beat earnings tomorrow, but I don’t expect gangbusters commentary from management on the conference call. Combine that view with the technical backdrop that shows support at 33.50 and resistance at 36.50, and I think a Jan / Feb calendar with no directional bias is a good risk/reward trade.
TRADE: WFC ($35.08) Bought the Jan / Feb 35 Call Calendar for $0.24
-Sold 1 Jan 35 call at 0.63
-Bought 1 Feb 35 call for 0.87
Break-Even:
Based on where I think implied vol will settle tomorrow, I expect that this calendar trade will be profitable as long as WFC stays between 33.50 and 36.50 tomorrow. Ideally, the stock ends up at 35 by Jan expiration next week, but I might take the trade off tomorrow if the stock hardly moves.
Trade Rationale: If WFC moves more than 4%, then I’ll have a loser on my hands tomorrow, but I’m not risking much, and could probably take the trade off tomorrow for only a small loss as long as the stock doesn’t have a 5%+ move. Given that, I like the vol dynamic of this trade, since I have no strong directional view.
Original Earnings Preview:
Event: WFC reports Q4 earnings Friday before the open. The options market is implying about a 3% move post-earnings, which is above the 4 qtr avg move of about 2.5%, and below the 8 qtr avg move of about 4%.
Sentiment: Wall Street analysts are somewhat bullish on the stock with 23 Buys, 17 Holds and 1 Sell, and an average 12 month price target of around $39. Short interest has been low in the name for years, and sits at 0.6% of float.
Fundamentals / Valuation: WFC is the largest U.S. bank by market cap, at around $184 billion. Its bread and butter over the years has been the residential mortgage market, as almost half of its balance sheet consists of loans tied either directly or indirectly to residential real estate (mostly mortgage and home equity loans). [private]
WFC is also a purely domestic bank, and most of its business is in retail and commercial banking, with a small investment banking business. While the stock has benefited from the recent strength in U.S. housing as a result, I have been surprised that WFC has not rallied more as a result of that strength. Part of the problem is that as rates have moved lower, refinancing of U.S. mortgages has been a burgeoning business for the large cap banks, but there is little juice left in that gravy train with rates already this low. In addition, large cap banks have booked gains on their loan loss reserves for the past 3 years, leaving little additional benefit from that cookie jar going forward. Finally, WFC already trades at a price-to-book of 1.3, not expensive, but not as cheap as some of the alternatives in the space.
Price Action / Technicals: The stock made new bull market highs on the QE3 announcement by the Fed in September, but has been a relative underperformer compared to other financials since then (many of which are at multiyear highs). The 3 year chart shows a stock that has been rangebound, but now trying to resume the initial breakout above $34 from September:
WFC 3 yr chart from Bloomberg
I don’t think the chart offers much insight here, except to illustrate obvious resistance in the $36 level, above which there is little psychological resistance.
Volatility: Not a heck of alot going on in the options as far as implied vol goes. There’s a slight uptick into the earnings but nothing massive.
1 Yr HV vs IV from LiveVol Pro[/caption]
Jan options are in the high 20’s and should settle in the low 20’s following the report. February is already under 20 so won’t come in much.
My View: Analysts don’t expect any fireworks from WFC in the Q4 report (and WFC usually comes in close to consensus estimates). The important point on earnings will be 2013 guidance, where analysts are only projecting 7% earnings growth. If WFC indicates expectations for 2013 loan growth as robust, along with good cost control, then the stock has a chance to make new highs tomorrow. But more nuanced commentary likely results in more churning for what’s been a boring stock for a while now.
If we do any trades, we’ll be posting them tomorrow.