New Trade $GS: Hope Springs Eternal For U.S. Banks

by Dan March 22, 2013 2:32 pm • Commentary

Here is a summary of what I will be discussing tonight on Options Action on CNBC at 5:30pm:

Ok I get it, Euro Bank/Debt Contagion fears are SO 2011/2012, but my sense if the last 2 spring/summer serve as a decent point of reference it may be worth U.S. investors time to think hard about the short term pain felt on this side of the Atlantic.  In the spring of 2011, it was Euro Debt fears that caused the initial 10% decline from 52 week highs in the SPX, and then our own little shenanigans added the second 10% decline……Then again in the spring of 2012 a 10% peak to trough decline as Euro Debt fears reared their ugly head again.  The SPX seems destined to have one of its best Q1 closes in the last 20 years, but what could possibly be the spoiler in Q2??

As we head into the Spring and Cyprus is the disaster of the season, I want to identify a few reasons why I think U.S. banks could be vulnerable in the coming months and single out one name, GS to express a near term bearish view:

  1. European Stress.  Enis’ CotD post detailed the divergence between European banks and U.S. banks.  European banks are signaling that the problems in the periphery might be more serious than just a blip on the radar in the healing process.  While the focus is on Cyprus, Italy has yet to form a government.
  2. Stress Tests.  The Federal Reserve singled out GS and JPM for their lax risk management processes, though did not reject their capital plans.  However, this increased scrutiny is likely going to make the hard-charging traders at GS think twice about swinging for the fences, and is an overhang that could reduce risk-taking appetite overall.
  3. Strong Q4 Earnings Raised Expectations.  GS reported a very strong Q4 number, and the stock gapped higher and didn’t look back, rallying for practically a month straight, from the middle of Jan to the middle of Feb.  However, GS earnings have been notably volatile for the past 5 years, so optimistic earnings expectations for 2013 based on one strong quarter could be a setup for disappointment.

Looking at the technicals, in the past 3 years, breaks of the 50-day moving average after multi-month uptrends have generally signaled forthcoming weakness in the stock.  Those previous instances are circled in red below:

3 year daily chart of GS, Courtesy of Bloomberg
3 year daily chart of GS, Courtesy of Bloomberg

From a vol perspective, options buying is compelling because GS is one of the few stocks in the current quiet market where implied vol is actually below recent realized vol.  Here is the 30 day IV (red) vs. 30 day RV (blue) chart, Courtesy of LiveVolPro:

Screen Shot 2013-03-22 at 1.58.01 PM

 

Add to this picture the fact that the next earnings report in GS falls before Apr expiry, and 1-2 month options look priced too cheap in the name.  I wan to be clear about this, I am not pounding the table, and suggesting the sky is falling, but if we do see the slightest bit of uptick in the recent developments in Europe, we could have a redux of the past few springs.

TRADE: GS ($146.80) Bought the May 145/135 Put Spread for 3.00

-Bought 1 May 145 Put for 5.00

-Sold 1 May 135 Put at 2.00

Break-Even on May Expiration:

Profits: btwn 142 and 135 make up to 7, max gain of 7.00 below 135.

Losses: of up to 3.00 btwn 142 and 145, max loss of 3.00 above 145.