Shares of Wells Fargo & Co (NYSE:WFC) traded up to a fresh new all-time high at the $60 level yesterday before selling off slightly. This was mostly predicated on renewed hopes for beneficial tax treatment for the big banks emanating out of Congress.
Like nearly everything else coming out of Washington, though, the tax plan will likely be big on hope but disappointing on substance.
Given the other headwinds now facing banks in general and Wells Fargo in particular, I expect the rally in WFC to stall out at current levels.
Let’s face reality — banks are rarely if ever truly penalized (and obtusely rewarded at times) for the morally bereft manner in which they sometimes conduct business. One only need to examine the Financial Crisis of 2008 to truly discern the favorable treatment for the Too Big To Fail institutions.
New allegations of inappropriate business practices continue to haunt Wells Fargo, even after the fake account scandal rocked the company earlier. Apparently all is forgiven and forgotten (but likely little changed) as WFC rockets towards new highs.
The latest earnings report hinted at a slowdown in revenues, especially from trading. Fundamentally, shares of WFC are fast approaching the highest P/E ratio over the past five years at over 14.
The last time Wells Fargo carried such a high multiple was also the last time shares approached the $60 level in late February — which also was the precursor to a nasty 15% correction in WFC. Net income continues to deteriorate at an alarming pace even with the stock continuing to head higher.
Click to Enlarge The yield curve is by far the flattest seen over the past year, as evidenced by the 2/10 Treasury chart. Banks typically lend and collect long-term rates and pay out short term rates on deposits. They make money on the spread between longer term rates and shorter term rates, a concept known as Net Interest Margin (NIM).
So the flattening of the curve is a decided negative for NIM, a key component of banks overall revenues.
Click to Enlarge As a trader, my job is to make money, not pass judgement. So putting the moral issues aside, WFC stock is looking decidedly overbought from a technical perspective. The 9-day RSI is now at the highest reading of the past year, breaching the 80 level. Previous instances when Wells Fargo stock approached such extremes coincided with significant short-term tops in the stock.
MACD also echoes a similar euphoric sentiment and is also at the highest level of the past year. Shares are up nearly 10% just over the past two weeks. A pullback, or at least a period of consolidation, appears likely given this technical backdrop.
Click to Enlarge With implied volatility (IV) still near recent highs, option selling strategies make sense. So to position for the recent rally to fizzle, a bearish call credit spread makes sense.
WFC Stock Trade Idea
Buy WFC Jan $65 calls and sell WFC Jan $62.50 calls for a 40-cent net credit.
Maximum gain on the trade is $40 per contract with maximum risk of $210 per contract. Return on risk is 19%. The short $62.50 strike is above the major resistance level of $60 and provides a 5.28% upside cushion to the $59.36 closing price of WFC.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at timbiggam@gmail.com.
