Trade Update $XLF: Spreading July Puts

by Dan June 21, 2013 12:38 pm • Commentary

Trade Update June 21st, 2013:   I am going to go back to the weakness in European Bank stocks that I highlighted last week as the impetus to initiate the bearish view on the XLF.  The Euro Stoxx Bank Index is down 6% and approaching a very key support level, the XLF is now down about 3.5% in sympathy. While I think we see a continuation of this weakness into July, and possibly crescendos a bit into Q2 bank earnings.  I wan to keep some exposure on the short side, but I want to use this near-term weakness to reduce my break-even on the trade.

Action: XLF ($18.95) Sold July 18 put at .19 to open
New Position: XLF ($19.67) LONG July 19 / 18 put spread for .09

New Break-Even on July Expiration:

-Profits of up to .91 btwn 18.91 and 18, max gain of .91 at 18 or below.

-Losses of up to .09 btwn 18.91 and 19 and max loss of .09 above 19




Original Post June 13th, 2013:  New Trade $XLF: Bank Shot

I have mentioned the relative weakness of European banks over the last 2 weeks on more than one occasion by highlighting the EuroStoxx Bank Index (SX7E).  Prior to reversing today, the index was down 12% from the May 2oth highs, and nearly 18% from the 52 week highs made in late Feb.  The one year chart below shows a fairly impressive looking spike bottom that could see a bit of continued bullish follow through, but the chart on a longer term basis looks like a textbook head and shoulders top formation with 100 euro as the neckline.

Euro Stoxx Bank Index (SX7E) 1 yr chart from Bloomberg
Euro Stoxx Bank Index (SX7E) 1 yr chart from Bloomberg

What has become apparent is that the powers that be in the EuroZone have taken the notion of systemic risk off of the table, as I laid out in a little charting exercise this am in the MorningWord (read here). But risk assets the world over are moving around in fairly un-predictable ways with few good reason.  IN a market like this, and despite central bankers stated wishes to do “whatever it takes” to maintain stability, we can get short-term market dislocations.

And maybe, just maybe it is that time of year for the markets to be rattled a by a little scare from the banking industry.  Remember that the summer of 2011 was marred by BAC’s need to raise capital, last summer was marred by the London Whale at JPM, and just this past week their have been unsubstantiated reports that Citi could possibly been sitting on a $5 -$7 billion loss as the result of the recent move by the yen vs the dollar (here).

My comments above are not intended to fear monger, but it makes sense to me that if we have a continuation of the swings that we have seen in commodities, currencies, bonds and and lately in equities, that bank stocks, which have had an amazing run ytd both here and abroad, could be vulnerable to a mid year swoon.

With the market up, and having covered some shorts over the course of the week, I want to place a small out of the money bearish bet that over the next 5-6 weeks we see some good old fashioned bearish summer activity in the bank stocks, on our shores.

Trade: XLF ($19.67) Bought July 19 puts for .28

Break-Even on July Expiration:

-Profits below 18.72

-Losses of up to .28 btn 18.72 and 19 with max loss of .28 above 19

Trade Rationale:

Without trying to make a play on an individual name, implied vol looks fairly reasonable on XLF trading at the very low end of the 2 year range, despite the recent uptick as the index has been moving around bit near the 52 week highs.

XLF 2 yr 30 day implied Vol vs Realized Vol from Bloomberg
XLF 2 yr 30 day implied Vol vs Realized Vol from Bloomberg

What I like about July expiration is that many of the large components will report Q2 earnings in this expiration, and if I am right that the recent volatility around risk assets sticks around for a bit, the U.S. banks stocks could, as usual find themselves in the eye of the storm, even if it is just a “tempest in a teapot”.

If we did see a selloff from here I would either look to spread the puts by selling the 18’s or just think about taking profits on the 19’s.

I would also add that there were large buyers of the July 18 puts yesterday, over 50k traded for .16 and there was a large buyer of the Aug 19 puts where one trader bought 32k for .24.