Investors in U.S. bank stocks have been torn this year with an uncertain and unexpected rate environment, coupled with the headwinds to earnings growth from increased regulation. As a group, it has been hard to put your finger on one consistent theme, but it is somewhat surprising to see “best of breed”, Goldman Sachs (GS) underperform the broad market and the XLF by a few % points on a year to date basis. GS is expected to deliver 7% earnings growth in the current year on sales growth of only 2%. Next year, Wall Street analysts expect only 1% earnings growth on sales that are expected to decline 1%. As investors have lowered expectations, the stock is cheap at 11x next year’s expected earnings, and a 1.2x tangible book value.
From a technical standpoint, the stock is approaching key long term resistance at $190. Interestingly right at the high from 2009:
Despite the relative under-performance, on a near term basis the stock has made a very nice consolidation at the multi-year highs:
30 day at the money IV looks fairly reasonable but is still a tad elevated from the 52 week lows made in August:
Two options overlays stand out for existing longs given the set up:
For existing longs, leverage trades could be an interesting play for a year end rally in the shares. Risk reversals that entail selling a downside put to buy an upside call for little to no premium make sense. For instance, with the stock at $190, you could sell the Jan 2nd weekly 185 put at 2.60 and buy the Jan2nd weekly 195 call for 2.10, taking in a .50 credit. If the stock were between 185 and 195 you receive the .50 credit plus or minus the gains or losses of the stock. If the stock is below $185 you would be put the stock on Jan2nd weekly expiration and experience losses. But if the stock is above 195 you would have gains of your stock, the calls, and the credit received for the package. You would only do this trade if you were are willing to add to your existing position (as a leverage trade) or comfortable being put the stock at 185 (or suffering losses prior to expiration if the stock were to get close to your short put strike). The highest probability outcome is that you receive the .50 in premium.
On the flip side, if you are just hanging on and don’t want to book gains in 2014 but think the relative underperformance is concerning, look to protect your holding with a put spread collar. Against 100 shares long at $190, sell to open 1 Jan 195 call at 2.80 and buy 1 of the Jan 185/170 put spread for 2.80. This protection has no premium outlay and let’s you participate to the upside to $195. You have losses of the stock between 190 and 185, but protected between 185 and 170 (the low from last month). The downside of the trade structure is that you only have $5 of upside, but getting very near the money protection. You would do this sort of overlay if you did not want to sell, yet were more worried about downside than upside over the next 2 months.