Big Banks Might be Resilient, But XLF is Still Vulnerable to Negative Earnings

Smaller banks need strong numbers to stay afloat

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This morning I am recommending a bearish trade on the Financial Select Sector SPDR ETF (NYSEARCA:XLF).

This ETF’s holdings are made up of many different financial stocks, including big banks like JP Morgan Chase & Co. (NYSE:JPM), Wells Fargo & Company (NYSE:WFC) and Citigroup , Inc. (NYSE:C). With earnings season approaching, financial stocks are in a tough position, and XLF may struggle as a result.

Holding Big and Small Banks

XLF’s top holdings are large banks like those listed above, and so far their earnings reports are mixed.

On Monday, C reported that it beat earnings per share (EPS) expectations by $0.06 (or $0.09 when accounting for the impact of the 2017 tax reform), but it missed its revenue target by over a quarter of a billion dollars.

Still, C was able to rally on this news.

WFC was in a similar situation, beating EPS estimates and falling short on revenue. WFC shares fell nearly 3% yesterday, partially because the Federal Reserve will restrict WFC’s growth longer than expected.

The Federal Reserve imposed these regulations after a series of consumer abuses, and it rejected WFC’s recent prevention plan.

JPM missed both earnings and revenue, but rallied anyways.

These big banks might be able to rally through mixed or even negative earnings reports, but XLF also holds smaller, regional banks like BB&T Corporation (NYSE:BBT), M&T Bank Corp (NYSE:MTB) and Zions Bancorporation N.A. (NASDAQ:ZION).

These smaller banks won’t be as resilient to negative earnings, and they start reporting later this week. If enough smaller banks start reporting mixed or negative numbers, XLF could fall.

Two Layers of Resistance

Looking at the chart of XLF, we can see a few areas of potential resistance. It formed support just above the $25 level in October of 2018. Regular readers know, old support can act as new resistance, and even if XLF makes it past $25, it will still have to cross the $26 level, which acted as support throughout November and December.

Daily Chart of Financial Select Sector SPDR ETF (XLF) — Chart Source: TradingView

XLF’s performance depends on both big and small banks, and it won’t overcome resistance without some positive earnings numbers from across its many holdings. For that reason, I am recommending a bearish trade this morning.

Using a spread order, buy to open the XLF March 15th $24 put and sell to open the XLF March 15th $22 put for a net debit of about $0.50.

A debit spread is simply a way to lower the cost of buying options, as the option that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this put debit spread is a way to lower the cost of buying bearish put options. Many brokers will require the use of margin and/or a set amount of reserved capital to execute a debit spread; contact your broker directly for specific requirements.

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Article printed from InvestorPlace Media, https://investorplace.com/2019/01/big-banks-might-be-resilient-but-xlf-is-still-vulnerable-to-negative-earnings/.

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