Big Printin’ – Euro Banks

by Dan July 14, 2016 12:58 pm • Commentary

In the lead up to, and the way out of the late June Brexit vote, European banks were thought to be the most vulnerable in the event of a Leave vote. They had already been beleaguered by the negative rate environment in the region.

The nearly 20% one day drop in the Euro Stoxx Bank Index (SX7E) the day after the Leave vote confirmed those fears. That was truly staggering:

SX7E ytd chart from Bloomberg
SX7E ytd chart from Bloomberg

And while the 17% bounce from the post vote lows is impressive, it’s important to note that the index has yet to fill in the gap. It is still down 45% from it’s 52 week year ago highs, down 30% on the year, and below its 2009 financial crisis lows (despite not quite matching its 2012 Euro Sovereign debt crisis / Grexit lows):

SX7E since 2009 from Bloomberg
SX7E since 2009 from Bloomberg

SX7E remains in the sick-bay, even after the recent bounce. But on a day where U.S. banks have reason to rally (JPM’s results) its worth highlighting some unusual options activity in two European Bank Stocks thought to be in the eye of the storm, Deutsche Bank (DB) and Credit Suisse (CS). Let’s go to the trades:

First in DB. When the stock was $14.50 a trader bought what appears to be bearish positioning, selling to open 3,000 Oct 15 calls at $1.32, or $523,000 in premium and using the proceeds to buy to open 10,000 Oct 10 puts for 40 cents each, or $400,000 in premium.  This could be an outright bearish bet, as a trader looks to finance out of the money puts by selling near the money calls.  Given the elevated levels of options prices, this sort of structure may be preferable to an outright short stock position. It adds serious leverage to the downside (short 3k calls vs long 10k puts), and the potential for the short calls to offset decay in the out of the money puts over the next 3 months. The risk on a trade like this is the stock is clearly squeezey, and is one Draghi back-stop tape-bomb away from the high teens.

DB is approaching an interesting technical level at $15, the February low, that served as support in 2016 until the Brexit debacle:

[caption id="attachment_65000" align="aligncenter" width="600"]DB 1yr chart DB 1yr chart[/caption]

While equity volatility remains elevated, with 30 day at the money implied volatility (the price of options) still in mid 40s%, down from 70% last month, and 87% in February, I think it makes sense to keep an eye on the cost of insuring DB’s debt, with DB’s 5 year CDS elevated:

[caption id="attachment_65001" align="aligncenter" width="600"]DB 5yr chart of 5yr CDS from Bloomberg DB 5yr chart of 5yr CDS from Bloomberg[/caption]


In CS, there was an opening buy of upside calls in Sept expiration.  When the stock was $11.35. a trader paid 65 cents for 10,000 of the Sept 12 calls. These calls break-even at $12.65, up 11% from the trading level. In vol terms these calls are expensive, but given the stock’s precipitous decline, one headline about backstopping Euro Banks by the ECB could have these calls in the money in a quick.

I’ll offer our usual disclaimer, without intimate knowledge of the trade, the intent of the trader it is impossible to make any concrete conclusions. For instance maybe the CS Sept 12 calls look dollar cheap to a trader who thinks the stock is going to be a hat size, and they could serve as a stop on a short position.  And putting these two trades together offers little to know value as to trying to gleen anything as one appears bearish and one bullish.  But as always its interesting to keep tabs on this activity as nothing more than a sentiment input.

Lastly, any way you look at, pressing the short in Euro Banks is a tough trade given extreme negative sentiment, and the powers’ that be vested interest in avoiding a bank crisis causing contagion at a very fragile point in the global economy and financial markets.