Regular readers are familiar with my views on bank stocks (from April here and early June here). Given the weakness of most into and out of the Brexit vote late last week we took the opportunity to roll existing bearish positions (in XLF here and Citi here), after being a little early to the trade (read wrong), we got bailed out, but fully recognized the potential for a bounce after a period of shear panic. While Brexit was not part of the bearish thesis, it did nothing other than to reinforce my thought that the current rate and regulatory environment, (despite the recent stress test nod to higher share buybacks and dividends in the group) will likely cause the group to re-test their February lows in the back half of the year.
The bounce this week in the EuroStoxx Bank Index (SX7E) has been pathetic, and frankly looks more like a stabilization than a meaningful recovery, suggesting that there are lower lows to come:
The 10 year chart of the SX7E shows just how dire the situation is for the group, below the 2009 financial crisis lows, down about 50% from its 2015 highs and a few tape-bombs away from its Euro Sovereign debt crisis lows near $72:
Euro banks are a very hard press on the short side as a whiff of the ECB expanding support for financial institutions, basically doing whatever it takes would probably cause a temporary but epic short squeeze. In the meantime we have yet to see capitulation, and that will be the point to cover shorts in global bank stocks.
And that brings me back to the U.S.. It makes sense to target U.S. banks on the short-side if you agree with my view that we have yet to have capitulation in Europe. And it makes most sense to target those with lots of exposure to the U.K. and Europe. Last Friday, Jay Jenkins at the Motely Fool wrote a post detailing Bank of America’s (BAC) exposure to the U.K.. The SEC filings shows greater exposure than that of J.P. Morgan (JPM) a far larger bank:
The next identifiable catalyst for BAC will be their Q2 earnings July 18th before the open, and while expectations are not particularly high, the outlook for the balance of the year is likely to be at least as bad as investors and analysts expect, and probably worse given what should remain a fairly volatile situation in Europe that should keep global rates in the shitter. Yeah BAC is cheap at .54x book and this week’s approval by the Fed for the bank to buy back $5 billion of their shares in the next year (vs $4 billion last year) and raise their 5 cent quarterly dividend to 7.5 cents, is mildly positive. But it’s not likely to move the needle on earnings or sentiment.
Shares of BAC are among the worst performing banks in the U.S., down 22.5% on the year, and down 30% from its 52 week highs, having just this week bouncing off of key support at $12:
A retest of this week’s lows would likely put the February 3 year low of $11 in-play, and a look at the chart since 2008 shows the long term uptrend just below $10 as a reasonable target in the event of a return to the sort of volatility we saw last August/September & January/February. It’s my view that the Brexit freakout was a mini-preview of whats to come in the back half of 2016:
So what’s the trade?
While short dated options prices are not exactly cheap in BAC, with 30 day at the money implied volatility at 32%, down from 45% on Friday, and 55% in February… they are cheap-ish.
I want to look to August expiration, which will catch their Q2 results later this month, and what could be a sort of crescendo for what is going on with European banks.
*Trade: BAC ($13.10) Buy August 13 put for 53 cents
Break-Even on August Expiration:
Profits: Below $12.47
Losses: up to 53 cents between $12.47 and $13, with max loss of 53 cents, or 4% of the stock price above $13
Rationale: BAC was $12.05 on Monday afternoon, the stock has benefited from the stabilization in European stocks and the news around the Fed’s Stress tests, but the under-performance of Euro banks from Monday’s lows, and the sharp drop in Treasury yields suggests to me that the lows are not in for bank stock’s this summer. This a defined risk way to get very near the money participation to the downside.