While I was on record foretelling a Donald Trump victory in the U.S. election, I could not have guessed the market reaction as it unfolded. Since the election, Bank of America Corp (NYSE:BAC) rallied around 20% in just five trading days. This was not a result of BAC-specific news. The entire sector rallied as part of a reflation anticipation rally.
We saw similar rallies in JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC) who also rallied just under 20% in as many days. Traders were indiscriminate buyers even ignoring the WFC fraud case.
Goldman Sachs Group Inc (NYSE:GS) chart shows how fast GS stock has leaped from a measured-move breakout to near decade-highs. This also shows the technical upside potential so serves as a reminder that today’s trade is of medium conviction.
Fundamentally, one can argue that banks have been undervalued for years. But a move this fast argues that they’ve now gone too far too fast.
Click to Enlarge In just a few days, BAC is finally back to 2008 levels. The long-term chart also shows the importance of this level. It’s served as resistance before in 1998, and acted as support in 2000. Then, in 2008, the financial debacle was too violent and support was lost for the better part of a decade. Here we are at it again.
While I am not arguing against the value of BAC stock at a price-earnings ratio of 15, I am concerned about the speed with which BAC shares reached this level. It’s the too far, too fast scenario.
For this, I want to take a limited risk on a downside scenario. Since I don’t have a specific fundamental bearish reason to short BAC, I will use the options market to set a mid-term trade to capture a retracement.
Consider this a lottery ticket. When placing directional bets with weak conviction, I use spreads. I often prefer placing the trade close to current price. This way, any move in my direction would start accumulating profits. Otherwise, if I place my spread too far from current price, I would need to not only guess the correct direction but also the size of the move.
The BAC Trade: Buy the BAC Dec $19/$18 debit put spread. This is a bearish trade for which I pay 23 cents per contract. Ideally, I need BAC stock to fall through both legs of my trade before mid December to win. If that happens, I stand to more than double my money.
I could mimic this trade by shorting the Financial Select Sector SPDR Fund (NYSEARCA:XLF) instead of Bank of America. The advantage of using the XLF is that I would limit my exposure to the possibility of a BAC specific positive headline. But recently, Banks have been trading in unison so I don’t see much advantage in doing so at this time.
I am not required to hold my trade through its expiration. I can close it at anytime for partial gains or losses.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
