The banks have had an insane six month rally. Since the U.S. elections, the Financial Select Sector SPDR Fund (NYSEARCA:XLF) rose as much as 25%. The underlying bullish thesis has been built on the hopes of fewer regulations and higher rates. The steep rally suggests that there was a situation of gross sector mispricing that needed correcting.
The ongoing debate on Wall Street is whether we priced in too much bank “hopium.” There are strong opinions on both sides of the argument, but I bet that somewhere in the middle lies the truth.
That will be the basis of my trades today: I want to sell risk against both extremes of the bull and bear cases in U.S. financial equities for the next few months.
I usually stick to trading the cream of the crop. So I will share setups in JPMorgan Chase & Co. (NYSE:JPM) and Goldman Sachs Group Inc (NYSE:GS). I will also write blanket spreads in the Financial Select Sector SPDR Fund (NYSEARCA:XLF).
The main idea here is to create income from a range in prices. The fundamental cases for both JPM and GS are beyond doubt. The same can be said about the XLF since most other U.S. banks have been fortified well for the next financial debacle.
Bank Stocks to Trade for Free: JPMorgan (JPM)
Click to Enlarge Fundamentally, JPMorgan is considered a premier bank. Management is a proven performer, so unless we have another financial black swan event, they should do well.
Technically, however, there is worry. JPM stock shows a potential bearish pattern looming just below. So a small dip could invite sellers down to $83 per share or lower.
Sell the JPM Dec $77.50/$75 put spread versus the $97.50/$100 calls, an iron condor, for $1.20 per contract. This trade has a lower starting theoretical chance of success than my usual trade, but for the 70% potential yield I am willing to take the risk.
Each side still has a 75% chance of success. Also having so much time on the clock makes them easy to manage the short-term price gyrations.
Bank Stocks to Trade for Free: Goldman Sachs (GS)
Click to Enlarge Goldman Sachs, while it no longer carries the same clout it did ten years ago, is still a beast. So in the long term, assuming equities in general don’t collapse, GS stock should thrive.
Like JPM, GS stock also shows some technical vulnerability looming, but not as pronounced. So I am willing to risk money going long its value as long as I leave room for error.
Sell the GS Oct $185/$180 credit put spread for 65 cents per contract. This is a bullish trade that has a 90% theoretical chance of success to yield 14%. I will sell opposing risk to balance the GS bet.
Sell a bearish GS Oct $270/$275 credit call spread for an additional 60 cents with the same metrics. Taking both side would raise the potential yield to 30%.
Bank Stocks to Trade for Free: Financial Select Sector SPDR Fund (XLF)
Click to Enlarge Considering the technical precarious situation that both JPM and GS stocks show, it’s no surprise that the XLF exchange-traded fund also needs a bounce off these level or risk more downside. The fundamentals of each of its components extend to the ETF.
So XLF is as solid there as its holdings. So there is no knock on it under the current conditions. It would need a new nasty headline to emerge which doesn’t seem unlikely.
Sell the XLF Dec $21/$20 puts versus $26/$27 calls, an iron condor, for 45 cent per contract. Again, here the starting chances of success seem too aggressive, but I believe they are well-balanced considering the range I chose.
If XLF stays between both sold spreads, I stand to reap more than 75% yield on risk. The profit area is represented on the chart.
Learn options as easy as 1-2-3 here. 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.