Big Week for the Banks

Here are two ways to make bank on the Fed's report on the banks this week.

   

Thursday is a big day for U.S. banks. On that day, the Federal Reserve will provide its final word in the latest round of bank stress tests and in turn will signal or state whether individual banks can raise their dividends or buy back shares or do both.

Last week, the Fed gave thumbs up to the ability of all but one bank to withstand some economic and financial market shocks. It will take things a bit further on Thursday and tell the banks if their plans for their capital base going forward are adequate. It is comment and approval of these plans that will tell us about each bank’s ability to raise dividends or buy back shares.

The two big banks with the most to gain are Citigroup (NYSE:C) and Bank of America (NYSE:BAC). Both have been severely restricted from paying dividends – each pays a token dividend of a penny a quarter, something the Fed allowed them to do so they would not be eliminated from consideration by many mutual funds and pension funds.

The Street had a mixed reaction to the stress test results released last week. Yes, both Citigroup and Bank of America got an “all clear” but both were cited as having potentially large losses – BAC in the order of $50 billion – in the event of another financial market meltdown.  And the Street is having mixed reactions as we speak, so to speak, if you look at today’s pricing action.

What do to? You could speculate and buy some calls, but I think it wiser to sell (write) some puts that expire this week. Why?

First, the premiums are very rich and you get a great return on selling the puts when you annualize that return. Second, and this is particularly true for Bank of America, the stocks are cheap based upon trading trends. And this is even more true for Bank of America as the stock is cheap based on fundamentals.

Bank of America is circling the $12 price point, a great price to sell a put against, especially a monthly March put that expires this week. Write the put now, and if the stock moves up and the put expires worthless, you get an annualized return of 63%. And if you are put the stock,  owning BAC at $12 is a no-brainer. Simply turn around and sell calls against your shares to generate income every week.

Citigroup is a bit problematic as I am not a believer in the fundamentals of the company. I think it will eventually break itself up, but the stock price has sustained because of management’s insistence this will not happen. The stock is selling just under $47, so sell (write) the $46.50 put and you get around a 50% annualized return.

But if you only want to establish one position, BAC is a better stock if you are put the stock but Citigroup has a better chance of getting approvals from the Fed for a reasonable dividend hike and/or stock buyback. You could always take a half position in each one. But if you have to take just one position, make it BAC. For purposes of full disclosure, I have banked with BAC or one of the banks it bought fore more than 20 years.

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