Two weeks ago we got back into the banks wit a put spread in the XLF etf. The thinking at the time was that with the dual risks in Europe of Greece and Ukraine meant that financial stocks were not pricing in enough risk of a spillover into banking. Since then the Greek bailout/bridge has advanced although there are still a lot of details to be hashed out. We’ve also had positive headlines with the Ukraine situation with a mutually agreed upon “cease fire.” The Greek deal is probably already a sell the news situation and the “cease fire” in Ukraine is a joke:
But markets did rally on these initial headlines and our structure is a losing one at the moment. With XLF at 24.30 it’s currently worth about 15c (at a cost of .35). But it’s not far from strike and any move back towards the 24 level and it’s back in business. As far as trade management the 50 day moving average of about 24.15 is something to watch. Holding that level on any move lower probably means we’ll need to take our medicine and close for a loss as the expiration on the trade is only a few weeks away:
But there’s enough headline risk upcoming that it’s a decent probability we get a shot below $24, at least more than the options market is pricing in XLF:
And as Dan pointed out earlier, there was some interesting options activity in big XLF components MS and C on Friday:
3. MS – options volume ran 2x average daily volume as puts outnumbered calls more than 3 to 1. When the stock was $36.18 around noon there were two large blocks of 10,000 March 32 puts bought to open for .13, with a total of 30,500 trading on the day. These puts break-even at $31.87 on March expiration, in a little less than a month, down 12%. These puts could be disaster protection against a long position, as the only scheduled events for banks in March are the Stress Test results from the Federal Reserve due March 5th and 11th.
4. C – the two most active strikes were puts, with 20,000 of the March 45 puts bought for .20 when the stock was 50.79, these looked to be closing. But when the stock was 50.56 shortly after the open on Friday a trader paid 60 cents for 10,000 of the Feb 27th weekly 50.50 puts to open, these puts break-even at $49.40, down 2.2% on Friday’s close at $49.40.
The stress tests usually aren’t big market moving events but someone probably doesn’t want to take a chance. So we’ll keep an eye on the $24.15 and $24 levels. It’s not really worth any adjustment at this point as the 22.50 puts aren’t dollar cheap enough to close and just be naked long the 24 puts. Right now the structure is only about 25 deltas, so a move back to $24 means the structure is still a loser, but at that point it’s probably worth about .25 and wouldn’t need much of a move below that level to become interesting. Unfortunately, if markets march higher and headlines trend more positive this becomes more of a lotto ticket with not enough premium to left to close and move on.
Two months ago we made a bearish play on banks, and closed a month later for a gain as the sector got hit on weak results from some of the large money-centers. The sector has since bounced in tandem with the strong Jan jobs data and the revisions to December that could suggest the Fed will hint to a rate increase mid year at the next FOMC meeting on March 18th. If February jobs data comes in hot in early March this will dominate fed Speak up until the meeting. The only real bullish case for owning bank stocks at the moment is the potential for higher rates sooner than later aiding their net interest margins that have been declining due to the Fed’s policy of ZIRP (read a solid description of the effects of low rates on banks NIMs from Forbes here).
My sense is that the potential for a negative spillover from the situation in Europe dealing with the Greece, and the heightened tension in the Ukraine could keep the Fed at bay as we know what last year’s sanctions on Russia did for Europe’s economy.
At this point $24 seems like a pretty decent re-entry for a short trade in the XLF given the etf’s failure after a more than 5% bounce in the last week. I want to target a re-test of last weeks low at $23, but play for a move lower prior to the Fed’s next meeting in March.
TRADE: $XLF ($24.05) Buy to Open March 13th weekly 24/22.50 put spread for 35 cents
-Buy to open 1 March 13th weekly 24 put for .45
-Sell to open 1 March 13th weekly 22.50 put at .10
Break-Even on March 13th weekly Expiration:
Profits: gains of up to 1.15 between 23.65 and 22.50, max gain of 1.15 at 22.50 or lower
Loses: up to 35 cents between 23.65 and 24, max loss of .35 at 24 or higher.
Rationale: This is a fairly dollar cheap way to play for a pullback. If the etf goes back to recent lows its a nice win. If it goes back to the October lows it’s a huge win. The risk is it hold this 24 level and grinds higher but we like the risk reward of the put spread.