MorningWord 1/17/16: Bank Turn?

by Dan January 17, 2017 9:40 am • FREE ACCESS

On Friday, Q4 earnings releases  from three large moneycenter banks, Bank of America (BAC), JP Morgan (JPM) and Wells Fargo (WFC) officially ushered in earnings season, one that will be of particular interest to investors looking for an uptick in economic activity in Q4, but also any change in outlook after a monster rally in the stock market since early November.  For the most part the 3 large banks did and said what they needed to, and the stocks stayed bid. But sectors like industrials may not immediately benefit from the change in economic conditions as a rising interest rate environment, coupled with the strong dollar may offset tailwinds from expected growth.

On Friday we took a look at CSX Corp (CSX), a rail stock that that is up 80% from its 52 week lows last February, and which has more than doubled the performance of the S&P 500 since the election (Dangers on a Train?). I iscussed the trade idea on Friday’s Options Action on CNBC:

While CSX reports tonight after the close and we think it makes sense to look past early reports this earnings season until any trends are confirmed. That is why we chose to look out to May expiration in a stock that was trading at an all time high. If our entry on the short side is early, we have a little time.

Back to bank earnings, on Thursday prior to the trio of Q4 reports we detailed three options strategies for existing holders of each, yield enhancement in JPM (here), potential leverage in BAC (here), and protection in WFC (here) and circled back post results on Friday morning (Bank Shots).

Friday evening my main man Carter Braxton Worth of Cornerstone Macro Research did some charting on Options Action in support of his thesis that the bank rally, which has stalled over the last month may be set to retrace a portion of the move since the Nov 8th election. Watch here:

Mike Khouw agrees with Carter that at the very least bank stocks could continue to consolidate gains (and not continue the near parabolic move that got them here in Nov and Dec) and chose to express a fairly neutral to lower move in shares of Citigroup.  Rather than commit premium to make a directional bet, the trade Mike detailed was a defined risk short premium trade, vs the stock at $59,.75, Mike sold the March 60 / 62.50 call spread at $1, selling 1 of the March 60 calls at $2.35 and buying 1 of the March 62.50 calls for $1.35. Mikes’s max gain is the $1 received, where he makes up to $1 between $60 and $61, and all below $60. Mike’s max risk on the trade is $1.50, between $61 and $62.50 with his max loss of $1.50 at $62.50 or higher. Mike is a smart options trader, and Mike likes selling spreads (as opposed to buying them) because he has a high probability of making a small sum if the stock does nothing and a relatively low probability of losing all of his premium. If he were to buy a a $1.50 at the money put spread and the stock just sits here, he loses a little bit every day as the options decay. If you think there is a greater likelihood that the stock goes down vs up during a certain time period, there are two ways to express this view, one with short premium, one with long premium. The short premium trade has higher odds of success, but risks more to make less. Here’s an example I detailed in the banks (XLF) on Wednesday’s Fast Money: