This has been a whipsaw year with regards to stock prices ever since the correction started in February. Investors have reacted to one headline after another but mostly centered around fears from Global trade wars.
But this week, bank stocks took center stage. Last night, we learned about how individual banks reacted to the U.S. stress tests. Most banks were free to announce their financial engineering plans for the next few months.
Wells Fargo (NYSE:WFC) announced an impressive $24.5 billion buyback plan. This effectively reduces their share count by almost 10%, which is very constructive for the stock price.
Coming into the event, bank stocks were too cheap and on a two week slide. Wells Fargo stock was selling at a price-to-earnings ratio of 13 and 1.4 price-to-book. Yet year-to-date, the WFC stock price is languishing by 10%.
Although Wells Fargo suffered some self-inflicted wounds when it tried to cheat some of its customers a while back, but has since suffered the regulatory consequences. But it looks like that thread of headlines has already worked its course. And therein lies the opportunity.
Technically, WFC stock is at a trend line and if it breaches it, it should invite buyers for more upside potential toward $59-per-share. But given how uncommitted traders have been this year, I am more certain of downside support holding than upside potential materializing in 2018. So my trade today is to generate income from what others fear and not needing a rally to profit. But if one comes, my greens come faster.
Recently, WFC stock bounced sharply off of $50-per-share and that looks like a solid floor. However if it does fail, the downside could carry it through to $47-per-share. While this is not a forecast, it is a scenario of which I have to be aware.
But I am comfortable owning shares of Wells Fargo at a discount from the current price and that is important for today’s bullish setup. I am lucky enough to be long WFC into the stress test event, but if I weren’t, I would also add a debit call spread for September for a chance to double my money on the breakout.
The Trade: Sell WFC JAN 2019 $47 naked put and collect 80 cents to open. Here I have an 85% theoretical chance that I would retain maximum gains. But if the price falls below my strike, then I own the shares and would suffer losses below $46.20.
Selling naked puts is daunting. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell the WFC JAN 2019 $47/$45 credit put spread. The spread has the same odds but would deliver 10% yield on risk. Neither trade requires a rally to profit. In fact, the stock can fall an additional 18% and I could still retain maximum gains.
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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 as @racernic on twitter and stocktwits.
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