Banks are stronger than ever thanks to the efforts put forth after the 2008-09 financial debacle. Fundamentally, they’re on solid footing, flush with cash and ready to thrive in a rising-interest-rate environment.
This is the sweet spot.
Banks also told us that they will defend their shares with plenty of financial engineering. After successful stress tests, big financials have been increasing their dividends and authorizing more stock buybacks. This puts the bears at a severe disadvantage.
Since consumer spending remains strong — especially in electronic transactions — I will extend my enthusiasm to cover the transactors. Credit card payments are only going to increase and I want to bet long those who handle them too.
Today, I want to look at five banks and other finance-related stocks that have plenty of bullish winds at their backs. But we don’t want to own any of these stocks (yet). Instead, we’re going to create income from thin air using options.
Why aren’t we buying outright? Because technically, most financials are near decade-long prices, and it’s typically a fool’s errand to chase prices. I’m not worried about valuations, just timing, which is why the smart play is betting with the bulls without actually owning the stocks themselves.
Today’s five trades are structured so the worst-case scenario ends in buying these companies at a discount. That is a totally acceptable outcome in this macro-economic environment. No matter what, we collect our money now. If we win, we retain maximum gains … and even if we lose, we get to buy great stocks at a discount.
In no particular order, here are five bullish trades on finance-related stocks.
Low-Risk Financial Bets: Bank of America (BAC)
Bank of America Corp (NYSE:BAC) is a premier bank that survived the worst financial debacle and a slew of legal challenges. It emerged better for it, though, and now can reap the rewards behind solid fundamentals.
Plus, I’m confident going long thanks to BofA’s financial engineering tailwinds.
BAC stock has value here, so even if I’m wrong, that’s fine — this is a good stock to own. Technically, Bank of America is at a pivot point, with a support zone below $22. Thanks to the bank’s strong fundamentals, I will assume support can hold through the rest of 2017.
The Trade: Sell BAC Jan $22 puts and collect 70 cents to open. This is our maximum profit if prices stays above the $22 strike price. If Bank of America does fall below $22, we’ll become owners, and we’ll start to accrue losses below $21.30.
Low-Risk Financial Bets: JPMorgan Chase (JPM)
JPMorgan Chase & Co. (NYSE:JPM) is another elite bank, and while it trades around $93 now, I bet it will be a triple-digit stock soon enough.
Fundamentally, JPM stock is reasonably priced, sporting a price-to-earnings ratio of 18 and a price-to-book ratio of 1.5. Owning JPMorgan shares isn’t a mistake whether you buy it a little lower or even a little higher from here.
Let’s sell puts for income, where we’ll get paid for the opportunity to own JPM stock at a discount.
The Trade: Sell JPM Oct $85 puts and collect $1 to open. Here, we have an 85% theoretical chance to earn maximum gains. We’d own at $85 and wouldn’t accrue losses until below $84.
Low-Risk Financial Bets: Square (SQ)
Short of a major debacle, Square Inc (NYSE:SQ) is likely to execute this well for years. Since I can’t yet value the company in its growth phase, I’d like to simply bet on the price action instead.
The reaction to Square’s most recent earnings report was negative even though the company beat on all counts and raised guidance. Expectations often outpace price, though, and a dip in those cases is necessary for more upside.
The Trade: Sell the SQ Jan 2018 $20 put and collect $1 per contract to open. Here we have an 80% theoretical chance of success. Should Square drop, we’d become owners at $20 and suffer losses at $19.
Low-Risk Financial Bets: PayPal (PYPL)
Momentum like this is hard to chase by simply buying outright, so instead, we can sell puts to participate while giving us a buffer for error. PayPal is relatively expensive, too, but its premium is tied to big future potential.
The Trade: Sell the PYPL Jan 2018 $44 put and have a 90% chance to earn 65 cents per contract if shares stay above our strike. Otherwise, we would own at $4 and accrue losses below $43.35.
Low-Risk Financial Bets: Financial SPDR (XLF)
Finally, for good measure, we can also bet on the sector as a whole via the Financial Select Sector SPDR Fund (NYSEARCA:XLF), which holds BAC, JPM and a number of other financial stocks.
We’ll go long by selling puts against fears that aren’t likely to materialize. The thesis here is the same as what we’ve discussed for BAC and JPM.
The trade: Sell the XLF Mar 2018 $23 put for 65 cents per contract. If shares stay above the strike, we’ll book max profits. Otherwise, we’ll own this ETF for $23 and manage that risk, and accrue losses at $22.35.
Selling puts is risky business, especially near all-time highs, so never risk more than you’re willing to lose.
Learn how to generate income from options 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.