Monday, June 13, 2011

Financial Order Flow Review

If you have been paying attention to our Options Flow Recap posts you might have been noticing some of the odd bullish option prints in BAC, C, and XLF recently.  

Friday @ 11am PST CNBC reports "Extra capital charge on banks maybe 2-2.5%, not 3%"

Unless you've been living under a rock you would have realized this if VERY positive news for the banks. Jamie Dimon and many financial lobbyist have been wining about it for months and it looks like they might have finally paid off the right people.  I'm not suggesting to go all in Financials here but I am suggesting to have a plan and a variety of possible positions you could initiate if the opportunity presents itself. 

Lets take a look at the recent activity: 

Friday June 10th: 
BAC trader sold 20k Feb 7/8 put spreads to buy the Feb 14 Call @ .09 debit

Risk reward @ expiration: 
Risk is the .09 debit between 8 and 14... then another $1 below 8... upside unlimited

Here is the risk profile for tomorrow:

June 9th: 
Bank of America Corporation BAC – 25,000 of the August August 11 / 14 call spread was bought and the August 9 puts sold for $0.30 net debit. The position was bought to open.

Here is what the risk reward looks like at expiration: 
This trade gets long stock at $9.30 and plays the upside from $11.30 to $14.

June 8th: 
C Citigroup Inc.  3019 Jan 12 37 puts trade on the bid at 3.20, opening, 43 delta
Trade gets long C at $33.80

June 7th: 
XLF Financial Select Sector SPDR (ETF) – 100,000 of the July 16 calls were bought for $0.0825.

May 25th:
BAC Bank of America Corporation Aug 13/10 bull reversal trades 4700X at 1 cent credit

May 24th
Citigroup Inc. – 10,000 of the January 12 35 puts were sold at $1.72 to buy the January 43 / 50 call spreads for $1.65

May 23rd: 
BAC Bank of America Corporation – 20,000 of the August 12 / 13 call spread was bought for $0.24. 

I think you get the point.  Interesting that these traders are going long August in BAC while earnings are projected to be early July, and their divided payout Aug 1st. 

There have also been some bullish research on the banks from various desk's and media outlets.  Here are just a couple: 

BCM's option desk:
"A long list of uncertainty: A key driver of Financials underperformance this year is uncertainty along many dimensions, including the impact and timing of Dodd-Frank regulation, bank capital requirements and SIFI buffers, regional differences in regulation and capital treatment, housing and mortgage foreclosure settlement issues, and the impact of the macro environment.

Risk markets generally do not like uncertainty: This can help to explain the weak performance of the sector. However, Financials volatility and skew remain surprisingly relatively tame with respect to the market and other sectors, in a historical context.

Is low Financials volatility an opportunity? We believe that sector rotation out of Financials has left the sector under-owned by investors with derivatives capabilities, thereby resulting in less demand for options. Given high levels of uncertainty, we believe there is a natural opportunity here.

"Hedge" underweights: We recommend using calls, call spreads or call spread collars as a "hedge" for underweight positions, using 6-month expiries, where call-spreads can have 4x or better payoff.

Buy volatility using options: Financials are a natural sector for long volatility positions, but such trades are not working in this low volatility world, so our preference is to use a short butterfly structure, which benefits from price movements and volatility increases, but has capped upside and downside.

Single-name Banks trades: We recommend OTM calls for C and ZION, and call-spreads for JPM, BAC and FITB for stock replacement, hedging underweight exposures, or positioning for upside."

I've also recently read that M&A in the sector is projected to heat up per recent valuations and by looking at the last financial M&A cycle. 

This is from Morgan Keegan: 

"BANK STOCKS BATTLING A PERFECT STORM AS ECONOMIC MOMENTUM SLOWS:  Our View: Bank stocks have underperformed all year long (KBW Bank Index down 11% versus a 1% rise in the S&P 500) and have experienced another round of sell-off over the last few weeks driven by the combination of 1) renewed uncertainty surrounding potential capital buffers for systemically important (SIFI) banks. Comments that banks must hold up to 14% Tier 1 (+700bps) have added significant pressure on bank stocks recently. We believe a required buffer of 50-300bps over the current 7% is likely, less for regional banks and would vary bank-by-bank on a sliding scale based on risk profiles, 2) weakening macro-economic data and pressure in the housing market, 3) mortgage-related liability exposure (including legacy repurchase claims and robo-signing penalties) and 4) ongoing overhang due to Dodd-Frank rules implementation.  Our Call: While caution is warranted given the soft patch that the economy appears to have hit (similar to a year ago), our view is that most of the bad news is priced into these stocks. We believe investors should continue to maintain exposure to the banking sector and use the current pullback to selectively build positions. Our view is that the economic recovery, although weak and uneven, is likely to be sustained and current cheaper stock valuations, with many profitable and over-capitalized banks trading close to tangible book values, offer some degree of downside protection. We recommend selectively adding to positions in banks that are well positioned to grow earnings, pay reasonable dividends and that have the management expertise and capital strength to withstand a slowing economy.  Highest conviction picks include: BBT, FHN, FITB, HBAN, IBKC, STI, TCBI, TRMK & ZION.  Positive catalysts that could turn the negative tide in bank stocks include: 1) Clarity on minimum capital requirements potentially before the end of the year, 2) continuing pick-up in loan growth. C&I growth is occurring (small business, middle and corporate markets). To us, this is best indicator for future job creation 3) Stable-to-improving macro-economic data including the job and housing markets, and 4) a settlement of the foreclosure and "robo-signing" issues and decline in losses tied to mortgage put-backs." 

From the Morning Note: 

"- Barron's feature positive on big investment banks. Barron’s argues that given the recent selloff in the sector, it could pay to buy profitable financial companies at these discounted levels. Barron’s points out that the book indicates liquidation value, which means that investors pay very little for franchises and earnings power. The article points out that regulations, weak economy and loan growth mortgage woes as well as slower institutional trading activity cause investors concern regarding financials. The article notes that some stocks, specifically Bank of America (BAC), Citigroup (C) and Morgan Stanley (MS), trade below tangible book. Barron's argues that based on book value and earnings, with the shares having the potential to rise 25% or more in the next year, the big financials might be worth a closer look. The article notes that if the shares rose 25%, several banks, including Goldman, Citi and Bank of America, would be about where they began 2011. The article also points out that the big U.S. financials, such as Citigroup, JPMorgan (JPM), Goldman Sachs (GS), Morgan Stanley and Wells Fargo (WFC) are better capitalized than most European peers."

Also interesting is that today while the ES was making lows the banks were showing some large relative out performance. 

On a future post we'lll look at some possible trades in the financial sector... specifically BAC.  If you have a trade idea in BAC send it to us and we'll let you know what we think.  Or if you have a thesis on BAC let us know what it is (time, price, iv, etc) and we'll fit an option strategy to match your thesis. 

No position at this time. Position declarations are believed to be accurate at time of writing but may change at any time and without notice.

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