One by one the early Trump Trades are coming undone. The U.S. dollar has round-tripped its entire move since the election, with the U.S. Dollar Index (DXY) down about 6% from its near 15-year highs made in early January. The 10 year U.S. Treasury yield is trading very near the lowest levels of 2017 and near the levels in the days right after the surprise election result, while the two / ten-year spread is at its tightest level since October, which may indicate impending economic weakness. Material stocks like U.S. Steal (X) has retraced its entire move since the election, so have most oil stocks. And then there are bank stocks, a sector that rocketed out of the gates on November 9th, accounting for a good bit of the gains in indices like the Dow Jones Industrial Average in November and December, but have woefully underperformed the broad market in 2017, with the XLF up 2% ytd vs the SPX up nearly 8% and the DJI up nearly 7%, but I guess most importantly down 6.5% from its 52 week and multi-year highs made on March 1st.
I want to focus on Goldman Sachs (GS) as a way to express the view that bank stocks may be the next group to give back its post-election gains. Back on April 18th GS reported Q1 results that sent the stock down nearly 5%, and while it is trading very near the levels of the day before earnings, the lack of bounce with the SPX at fresh all-time highs in mildly disturbing.
The next identifiable catalyst for the stock will be Q2 earnings on July 18th. If the company were to report results that resemble those of Q1, the stock will fill in what looks like an obvious air pocket back to $200, which also happens to be the intersection of the uptrend from the post-Brexit lows last June:
Short-dated options prices are just too cheap in my opinion given what I believe to be a brewing political storm in Washington this summer. 30 day at the money implied volatility (blue line below, the price of options) is nearing 52 week lows, while 30 day realized volatility (white line below, how much the stock has been moving) has picked up to 3 month highs, which might suggest long premium options trades might prove cheap for those looking to express directional views:
Lastly, the initial gains last year in GS were predicated on the potential for higher economic growth due to what would be a pro-growth agenda from the new president, including tax reform, deregulation, infrastructure spending and health care reform. I think it is safe to say that much of this will not be accomplished in 2017, and I suspect the administration, with a couple high profile GS alums, do not have the political capital to push through deregulation for their prior employer. (in case you missed it, Treasury Sec Mnuchin got savaged by Senator Elizabeth Warren last week on Capitol Hill has she tried to get him to explain his prior commentary on depression era regulation Glass-Steagal… if this is what they got, I would not bet on it).
So from where I sit, low rates, tight yield curve, lack of political capital and I am hard pressed to make a bull case for the banks, and frankly, I think we are in a market where you want to press weakness. GS looks like a great candidate to do so into Q2 earnings.
So what’s the trade?
GS $222.50 Buy July 220 – 195 put spread for $5
-Buy 1 July 220 put for 6
-Sell 1 July 195 put at 1
Break-even on July expiration:
Profits up to 20 between 215 and 195, max gain of 20 at 195 or lower
Losses up to 5 between 215 and 220, max loss of 5 above 220 or 2.2% of the stock price
Rationale: This is simple risk reward, a breakeven 7 dollars below looking out to July, but a risk/reward of just 5 to 20. If the stock were to fill in some of that gap back towards 100 this is a fairly inexpensive way to position with defined risk.