Trade Ideas, Trade Updates September 4, 2020

Update: XLF – Cover and Bid It!

by Dan

A couple of weeks ago on Aug 19th, I had the following to say on banks stocks (on my In the Money segment with Fidelity Investments and on RR) and detailed a defined risk bearish strategy in the XLF, the Financial Select etf:

Which leads me to my first trade idea in the XLF, the S&P FInancial Select etf that tracks U.S. bank stocks. It is my view that the relative underperformance in this group is more reflective of the weakness on Main Street as opposed to the euphoria on Wall Street. Low rates forever, flat yield curve, and large loan loss reserves have caused investors of all stripes (including Warren Buffett) to hit the pause button on the group. If there is a real vaccine sooner than later, more fiscal stimulus and optimism about a quicker than expected recovery in 2021, then banks stocks will be the next IT group in my opinion and likely outperform the which as performed so well during the pandemic. But in the next couple months I suspect banks break key technical support at their uptrend from the March lows:

So what’s the trade?

BEARISH TRADE IDEA: XLF ($24.95)  BUY OCT 25 – 20 PUT SPREAD FOR $1
-Buy to open 1 Oct 25 put for 1.15
-Sell to open 1 Oct 20 put at 15 cents
Break-even on Oct expiration:
Profits of up to 4 between 24 and 20 with max gain of 4 at 20 or lower
Losses of up to $1 between 24 and 25 with max loss of $1 at 25 or higher
Risks 4% of the etf price to possibly make up to 16% if the XLF is down 20% in two months

Well, the months of relative underperformance has turned into outperformance in the worst week for the broad market in almost three months. Clearly, in the earlier post, I was trying to thread the needle, playing for one more breakdown and then setting up to get long. This week’s price action is making me think twice about which direction the next big move might be.

With the XLF around $25.20, the put spread detailed above can be closed for about 90 cents or a 10 cent loss. If you think the market’s correction this week was just an opportunity to reload on the long side then it might make sense to close this bearish trade idea as we could be on the cusp of a rotation. 

JPM and BAC look the most attractive to me, or you could consider buying the Nov XLF 26 call for $1.05 vs $25.20, which risks 4% of the etf price to have near the money long exposure, with defined risk.

I would add that for those who are long a basket of bank stocks, the Oct put spread detailed last month still looks to be an attractive near-term hedge.

Obviously I don’t have a crystal ball, I am still not hopeful of a widely available vaccine, I am still very pessimistic about the ills of structurally high unemployment and the risks to small businesses heading into 2021, I also think rates are not going much higher than 1% in the 10yr UST anytime soon… so I am not bullish, banks are cheap though, and have taken massive reserves and if things are not as bad as I think and the market finds its footing soon, banks will be a solid play on the long side in the Fall.

The uptrend is the trade, if it holds and is ultimately able to break out above its 200-day moving average (in yellow) and establish a new range, the glass half empty could go to half full very soon if the economic data does not get materially worse: