Chart(s) of the Day: $BAC / $C & Update on Our $XLF Calls

by Dan January 3, 2014 4:17 pm • Commentary

Back in late Nov we made a couple bullish bets in Jan XLF options playing for a breakout to new highs into Q4 reporting season (below original trade and update from Dec).  In fact, 4 of the 5 largest components, equaling about 26% of the etf (BAC, C, JPM & WFC) all report the week of Jan 18th expiration.  After adjustments and expirations on the original structure we are just left long the Jan 22 calls for far less than if we had purchased them outright over a month ago, and like the set up as we head into earnings.

One reason for the increased optimism on the XLF trade is the price action in BAC so far this year, up more than 5% out of the gate and breaking out to multi-year highs:

BAC 1 yr chart from Bloomberg
BAC 1 yr chart from Bloomberg

Generally, I am not a huge fan of runaway breakouts but the stock has made a series of consolidations and builds the steam to establish a new range, which it appears to be doing now.  Also both the 50 (purple) and 200 (yellow) day moving averages confirm the action, with both rising.

Then there is C which has been consolidating between the high 40s and the low 50s since late spring, and now looks to be poised to break out:

C 1yr chart from Bloomberg
C 1yr chart from Bloomberg

Which leads me to the etf that we are long calls in, the XLF.  The one year chart looks a lot like the prior 2, as it should as they are 2 of its largest components, but with earnings and 2014 guidance likely to set the stage for the coming months, there is potentially lots of room to run in the near term:

XLF 1 yr from Bloomberg
XLF 1 yr from Bloomberg

One last point, Implied Vol is near two year lows in XLF, and considering we financed the purchase of these Jan 22 calls we are in a great spot to play for the upcoming earnings events:

XLF 2 year at the money implied vol from Bloomberg
XLF 2 year at the money implied vol from Bloomberg

BOTTOM LINE:  Whether I paid .20 for these calls when the stock was a few % lower, or own them for half that because of a calendar or a risk reversal, I still think they are a good own for the next couple of weeks even if they are purchased right here.  The risk reward with a break-even up only about 1.5% looks very attractive given the relative outperformance of the group ytd and with the earnings events to serve as a potential catalyst.



Previous Post Dec 19th, 2013:  Trade Update – $XLF: Bank Deposit

Towards the end of November we put on a couple bullish XLF trades (below) to position for a technical breakout in the new year of the bank etf. Currently the ratio spread (the first trade) can be adjusted in a way that closes any downside risk and leaves a free look to the upside. Here’s how:

ACTION – XLF ($21.61) Close Jan 21/22 risk reversal for even, leave long 1 Jan 22 call from original trade at zero cost

-Buying to close 1 Jan 21 put for .18

-Selling to close 1 Jan 22 call at .18


As for the second trade, the XLF Dec / Jan 22 Call Spread this trade is working out perfectly with Dec 22 call set to expire worthless tomorrow and we own the Jan 22 call for .10 (currently trading .18)



Original Post Nov 21st, 2013: 

Adult Swim Trade – $XLF: Bank Deposit

Yesterday in the MorningWord we detailed the out-performance of U.S. banks vs the Euro Banks in the first half of the year, and then the subsequent flip flop since July.  With JPM’s monster DOJ settlement out of the way, it appears that banks want to push higher as the XLF today is making new 52 week highs and building what technicians would call a flag.

XLF 1yr chart from Bloomberg
XLF 1yr chart from Bloomberg

Backing the chart out to the breakdown levels in 2008, when sector etf dropped off of a cliff during the throws of the financial crisis, the etf is now just getting back to those levels:

XLF 6yr chart from Bloomberg
XLF 6yr chart from Bloomberg

The technical set up certainly looks poised for a move higher.  If you are inclined to play for a meaningful breakout into the new year, and you are eyeing Q4 earnings results as a potential positive catalyst (4 of the top 5 components of the etf all report in Jan Expiration: BAC, C, JPM & WFC) then rather than buying the stock here, levered risk reversals could make a lot of sense.  For those who are not inclined to sell puts and are less interested in buying the years highs in an effort to get long exposure in the new year I will lay out a more conservative way to get long calls that offers much less delta exposure.

I am not personally dying to get long at the highs, but playing for breakout with options looks interesting.

 1. Adult Swim Trade Structure: XLF ($21.37) Sell 1 Jan 21 Put to Buy 2 Jan 22 Calls for Even $

-Sell 1 Jan 21 Put at .38

-Buy 2 Jan 22 Calls for .19 each or .38 total

Break-Even on Jan Expiration:

Profits: Above 22 see levered gains.

Losses:  Put 100 shares of stock at 21, losses below there.

Trade Rationale:  Despite being closer to the put strike, the nice thing about this structure is the potential for levered gains to the upside, with a fairly wide range on Jan expiration where there is no negative PnL.  I risk being put 100 shares at 21 on downside, down .37, but I get long 200 shares at 22, up .63 on the upside.  If you are inclined to buy the stock here, this has a more favorable risk/reward set up.


2. Conservative Trade Structure: XLF ($21.39) Buy Dec 27th/ Jan 18th 22 Call Calendar for .10

-Sell 1 Dec 27th 22 call at .10

-Buy 1 Jan 18th 22 Call for .20

Break-Even on Dec 27th Expiration:

If stock is 22 or lower the Dec call expires worthless and you own the Jan 22 call for .10 with a break-even then of 22.10 on Jan expiration.

Trade Rationale:  As I state above this trade near term has little directional exposure, but could be a way to own dollar cheap calls into the new year. There is a massive delta difference in this trade vs the risk reversal. This trade is threading the needle but with alot less risk. The risk reversal is the equivalent in deltas of long stock but with some leeway between 21 and 22.