Bank Shot (XLF)

by Dan July 13, 2020 1:22 pm • Trade Ideas

Earlier today Guy Adami and I discussed the set-up in bank stocks into earnings this week.

watch here.

Here are the names, dates and implied moves for the week:

Tuesday before the open (implied one-day earnings move):

JPM (5.6%), C (5.75%) and WFC (7.4%)

Wednesday before the open:

GS (5.75%), USB (5%), PNC (5%) & BK (5.9%)

Thursday before the open:

MS (5.3%) & BAC (6%)

Friday before the open:

BLK (2.75%)

This group above equals about 40% of the weight of the XLF, the S&P FInancials etf .On Friday the group mounted a fairly impressive reversal after what felt like weeks of declines and horrid relative under-performance with most of the XLF components rallying more than 5% with mild follow-through today:

It is worth noting that short-dated options prices while elevated as most are relative to pre-pandemic levels with 30-day at the money implied volatility (blue line below) is still below realized volatility (how much the etf has been moving, the white line below), so for those looking to express directional views with options, they don’t look that expensive on a relative basis, especially when you consider the recent price action and the poor sentiment:


The chart is pretty simple. Just bounced off of the uptrend from the March lows (support) and has resistance just above current levels. A breakout on better than expected news on the earnings front and the XLF is on its way back towards $26.50, near its June rejection at its 200-day moving average:


Bad sentiment, cheap stocks, the rest of the market is saying that the economy is coming back… the only thing holding back the SPX from new all-time highs is for the banks to signal the all-clear! Obviously low rates and flattish yield curve hurting the money-center banks and their exposure to defaults, bankruptcies, and their need for large loan loss reserves. They are the ones exposed to the U.S. consumer, housing, small businesses and bad debt from large corporations. On the flip side the investment banks like Morgan Stanley and Goldman Sachs act very differently, as they are exposed to the parts of the economy that have been buoyed by both fiscal and monetary stimulus resulting in massive trading volumes, restructurings, equity/debt issuance and now maybe a round of M&A.

If the money-centers don’t rain in the parade and their outlooks do not meaningfully differ from the sentiment post the Fed Stress tests last month, then the stocks could clearly rally. But if they are worse even with poor sentiment and cheap valuation they could be a signal that the second half might be a bit different than the record second quarter for Nasdaq stocks


So what’s the trade?

If I were inclined to play for a breakout I might consider the following defined risk trade idea:

Bullish Trade Idea: XLF ($23.75) Buy July 24th (next week) 24 – 26 call spread for 50 cents

-Buy to open 1 July 24th weekly 24 call for 65 cents

-Sell to open 1 July 24th weekly 26 call at 15 cents

Break-even on July 24th expiration:

Profits of up to 1.50 between 24.50 and 26 with max gain of 1.50 above 26

Losses of up to 50 cents between m24 and 24.50 with a max loss of 50 cents below 24

Rationale: this trade idea risks 2% of the stock price for a little less than 2 weeks with a potential payout of 6.3% if the etf is up 9.5% on the close on Friday, July 24th.


Or If I were inclined to fade whatever happens this week after earnings in the group and play for a break of the uptrend and a re-test of the June lows near $20 I might consider a put spread in August allowing for some time for this to playout:

Bearish Trade Idea: XLF ($23.75) Buy Aug 23 – 19 put spread for 75 cents

-Buy to open 1 Aug 23 put for 85 cents

-Sell to open 1 Aug 19 put at 10 cents

Break-even on Aug expiration:

Profits of up to 3.25 between 22.25 and 19 with max gain of 3.25 if etf below 19

Losses of up to 75 cents between 22.25 and 23 with max loss of 75 cents above 23

Rationale: this trade idea risks 3% of the etf price, breakeven down 6.3% and has a max gain of 14% if the etf is down 20% in a little more than a month.

This is a tough call on the short side given the weak sentiment. It almost makes the most sense to sell whatever rally that might materialize or sell weakness if it doesn’t…