MorningWord 12/6/16: Bank Shot

by Dan December 6, 2016 9:00 am • FREE ACCESS

Yesterday in this space we highlighted some unusual long dated upside call buying in Deutsche Bank (DB):

snip20161206_8

Regular readers know that we do NOT place too much emphasis on unusual options activity, as it is impossible to know the intent and the track record of trade/trader, without intimate knowledge of the trade. Even then, who knows what the options may be against as a hedge, delta neutral, yield enhancement/ leverage. You get the point. But we do often like to use unusual options activity as a sentiment input. Financial media often likes to refer to large trades in financial instruments that are not stocks or etfs as “smart money” and we have been trained to follow what the “pros” are doing. But in this example, with the purchase of Jan 2018 calls that are so far out of the money it would be foolish to impute any short term bullishness (which for the most is the time horizon most in the financial media care about). We highlighted the activity because it was unusual, and because it gets us to take a closer look at sentiment (often indicated by put/call ratios), relative performance to global peers etc.

Shares of DB have followed through to the upside today, making its two gains off of its early Monday morning post referendum lows 11%.  The Euro Stoxx Bank Index is up 3.3% and approaching a potential technical breakout that could put its March breakdown level in sites:

SX7E 2 year chart from Bloomberg
SX7E 2 year chart from Bloomberg

While the expiration and the break-even on those DB calls seem like an eternity in both space and time, I’ll remind you that the little formation above that looks like an attempt at a bottom, remains nearly 80% from its 2007 all time high:

SX7E 10 year chart from Bloomberg
SX7E 10 year chart from Bloomberg

So depending upon where you think we are in the deleveraging cycle or rolling financial crisis, the party could be just getting started for Euro Banks. I have no idea where we are, whether its been just one big bail out, and still a house of cards, but defined risk options strategies (not one year out and 65% out of the money) seem like the way to play for those who think there is a Euro financial system reflation trade on the horizon.

For comparison, XLF, the Financial Select etf primarily made up of large U.S. moneycenter and investment banks (Berkshire Hathaway makes up 10%) is up 380% from its 2009 lows, and is now only 25% from its 2007 all time highs.