Update: XLF – Banks Shot

by Dan October 11, 2018 3:16 pm • Trade Updates

On September 12th I detailed my bearish view on bank stocks (‘You Come At the King, You Best Not Miss’) following some financial disclosures from a few of the large money-center banks regarding Q3 financial results, that failed to lift the group, suggesting:

with a little less than three weeks left in Q3, I suspect results were softish, and given Citi’s reaction today we are not likely to see a reaction to “seasonal” results that will lift the under-performers like Citi, GS, MS and WFC.

In a month, C, JPM & WFC will get Q3 earnings kicked off on Oct 12th, followed by BAC on Oct 15th, GS on Oct 16th, and Morgan Stanley (MS) Oct 17th. These six bank stocks make up about 40% of the XLF, the etf that tracks the sector, with a few more reporting the week after.

Looking at short-dated options prices in the XLF, 30 day at the money implied volatility has risen from its August lows of about 12% (blue line below) to 14.5%, still well below the 2018 highs from January at about 28%, but more in line with the one year average of about 16%. This while 30 day at the money realized volatility (white line below) is at just 10%, this spread is fairly wide, obviously incorporating potential vol for earnings season. Options prices seem fair to possibly cheap over the next month

I detailed a bearish trade in the XLF in Oct 26th weekly expiration:

TRADE IDEA: XLF ($28.10) BUY OCT 26TH WEEKLY EXPIRATION 28/ 26.50 PUT SPREAD FOR 35 CENTS
-Buy to open 1 Oct 26th weekly 28 put for 55 cents

-Sell to open 1 Oct 26th weekly 26.50 put at 20 cents

In front of tomorrow’s earnings before the bell, where 25% of the XLF (C, JPM, WFC & PNC) will report Q3 results it makes sense to revisit this trade with the etf very near the short put strike. With the etf at $26.50 the trade that could have been bought a month ago for 35 cents is now worth $1.10. As this can only be worth $1.50 (the width of the spread on Oct 26th weekly expiration it makes sense to take the 75 cent profit, a little more than a double and move on.

 

A couple of days later (XLF – Bank Shot) I updated this trade idea for CNBC’s Options Action (watch here) and widened out the strikes a bit and moved it out to November expiration with the stock up a dime from the prior trade idea two days earlier:

XLF $28.20 BUY NOV 28 / 26 PUT SPREAD FOR 40 CENTS
-Buy 1 Nov 28 put for 58 cents

-Sell 1 Nov 26 put at 18 cents

Now with the etf at $26.50 this put spread is worth about $1.20, representing a profit of 2x the premium paid. Again I think it makes sense to take this gain and look to possibly roll a portion of the profits.

The XLF’s 5.5% decline this week makes it a very tough press on the short side into tomorrow’s earnings, especially when you look at the support level near $26 which it is quickly approaching:

 

But if I were two close either of the above trades detailed last month, I might consider rolling some of the profits out and down a bit playing for a total breakdown back towards $24:

 

So what’s the roll? I would only do this with profits of the above trade:

XLF ($26.50) Buy Dec 26 / 24 put spread for 50 cents

-Buy to open 1 Dec 26 puts for 90 cents

-Sell to open 1 Dec 24 put at 40 cents

Break-even on Dec expiration:

Profits of up to 1.50 between 25.50 and 24 with max profit below 24

Losses of up to 50 cents between 25.50 and 26 with max loss of 50 cents at 26 or above

Rationale: again, this is rolling profits down and out and playing for the big one, risking 2% to possibly make 6% if the etf is down 10% in a little less than two months.

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