Citigroup (C) Q3 Earnings Preview / XLF Hedge Update

by riskreversal October 12, 2016 2:07 pm • Trade Updates

Event: Citigroup (C) is scheduled to report its Q3 results Friday before the open. The options market is implying about a 3% one day move in either direction, which is a tad higher than the 4 qtr average one day move, and shy of the 10 year average of 3.5%.

With the stock trading at $49, the Oct 14th weekly straddle (the call premium + the put premium) is offered at about $1.50. If you bought that, and thus the implied earnings move you would need a rally above $50.50, or below $48.50 by this Friday’s close to make money.

Despite the stock’s recent bounce from support at $45 in the last two weeks, the stock remains down 5% on the year:

From Bloomberg
From Bloomberg

The recent 8% bounce in the stock since Sept 27th tracks the 15% rally in the 10 year U.S. Treasury yield, from 1.55% to today’s 1.79%, nearly equal to the expected raise in the Fed Funds rate at the Dec 14th FOMC meeting.  We know that banks of all kinds, especially moneycenters like C are desperate for rates to go higher so they can benefit from the higher net interest margins.

I think it is safe to say that expectations are not exactly high for bank earnings, and for the most part U.S. banks act ok despite nervousness about Deutsche Bank’s (DB) capital position and the phony account scandal at Wells Fargo (WFC).  That said, with the XLF (the S&P Financial Select etf) only a couple percent from 2016 highs, and up 25% from 2016 lows, the risks into a well telegraphed Dec rate increase may not be in the stocks.  I would also add that a Hillary Clinton presidential victory is becoming likely, and with Trump’s implosion so is the potential for the Democrats to take back the Senate. If this were to occur we’d possibly see Massachusetts Senator Elizabeth Warren become chair of the Senate Committee on Banking. That’s a major thorn in the side for CEOs of major U.S. banks.

On Friday here, and on CNBC’s Options Action I detailed what I deemed to be a dollar cheap short term hedge in the XLF (for those long bank stocks) into a deluge of bank earnings this Friday (BAC, C, JPM & PNC all report, about 40% of the weight of the XLF):

These puts that I detailed when they were .12 have remained bid this week, with the XLF at $19.54, they are trading at 12 cents. At this point, with just two trading days left, and only one to the earnings I might consider rolling out of these puts and look farther out for protection, not just capturing these earnings but the upcoming Fed meetings and possible turnover in banking oversight in Washington.

One trade for those long bank stocks is to close the Oct 14th weekly 19.50 puts at 12 cents and buy the Jan 19/16 puts spread in XLF for 45 cents. That roll establishes protection for an almost 20% correction at the short strike. And protection begins (breaks even) about 5% lower. That protection costs about 2%. So this is for those that want to continue protection and are willing to risk 2% to do so to essentially make banks holding bullet-proof to any normal correction into 2017.

For Citi (C) holders considering a short term hedge,

one might consider a put spread collar, selling the Nov 52.5 calls to buy the Nov 45/40 put spread. That trade structure can be executed for very near even money and protects against a post earnings decline below technical support. IT does risk the stock being called away in above 52.50 but that is 7.5% higher in the stock between now and Nov expiration. Its important to remember with collars that if the stock is through the short call strike you can always buy back the call and not be called away.