Q3 earnings season kicks off next week. The main event will come Friday morning with earnings from Citibank (C), JP Morgan (JPM) and Wells Fargo (WFC), three stocks that make up nearly 25% of the S&P Fiancial Select etf’s (XLF) weight. Despite some recent volatility caused by WFC’s phony account scandal, and the stock’s subsequent 1 month 10% decline, and concerns about Deutsche Bank’s (DB) capital levels, the XLF is just 4% from its 52 week highs made last November. To my eye the last last year highs should serve as healthy near term technical resistance, with $19 decent support:
The sector’s relative strength has a little to do with the bid in Treasury yields, as the 10 year yield is up about 15 basis points this weeks, above its 200 day moving average for the first time since January:
Traders are clearly getting ahead of a Dec Fed Funds rate increase, where futures are currently pricing about a 68% chance (at the highest it’s been). At this point it seems it would take a disastrous Oct jobs report to derail a hike in Dec:
If I were long C, JPM or WFC I would strongly consider a weekly hedge in the XLF. But given how dollar cheap at the money options are, I might just take a punt on some puts on their own:
So what’s the Trade?
XLF ($19.63) Buy Oct 14th weekly 19.50 puts for 12 cents
Break-Even on Oct 14th Expiration (next Friday):
Gains: below $19.38, down 1% from the current level.
Losses: up to 11 cents between $19.38 and $19.50, with max loss of 11 cents above $19.50
Rationale: this is a cheap short term hedge, risking less than 1% of the etf price targeting a one day event where a quarter of the weight of the etf reports earnings the day of expiration. For all intents and purposes, you are getting free look at Friday earnings throughout the week, as these puts are expected to decay a penny or two a day without any movement.
IF YOU DO NOT THINK THE MARKET WILL MOVE MUCH BETWEEN NOW AND MONDAY MORNING, IT MAKE SENSE TO BUY PUTS LIKE THESE AFTER THE WEEKEND.
But If you are inclined to shy away from weekly options as they have a low probability of success, and you are of the mindset that further weak economic data might push out a Dec rate hike, then you might consider buying the Dec 19 puts for 45 cents. These puts break-even at $18.55 below the technical support level identified above. This position could act as a hedge into the Dec Fed meeting for those long bank stocks in the event that they don’t raise, or a raise has been priced in.