Portfolio Protection for a Pullback

Negative interest rates hurt banks' ability to make money

Last week, I recommended a trade on the struggling airline sector, but I also noted the challenge facing financial stocks. With a bearish put on American Express Company (NYSE:AXP), traders can set themselves up for big gains.

The problem for banks and creditors is the possibility of negative interest rates, a complex, counterintuitive concept that would generally hurt their ability to make money.

President Trump has floated the idea of negative interest rates, and though Federal Reserve Chairman Jerome Powell dismissed the suggestion right away, the Fed is a flexible organization.

There was a time when the Fed buying corporate bonds was unthinkable, but now that’s happening.

It doesn’t seem like anything is off the table.

What Do Negative Rates Mean for AXP?

This isn’t a comprehensive overview of negative interest rates. The implications of such a change are massive, and if you look at a chart of the financial sector, represented below by the Financial Select Sector SPDR ETF (NYSEARCA:XLF), you can see that the discussion brought it closer to its recent lows.

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

To begin let’s just note that negative rates aren’t as impossible as they sound. The Bank of Japan (BOJ) and the European Central Bank (ECB) both have negative rates, and many European government bonds have negative returns.

If the Fed set the federal funds rate below zero, lenders would be forced to pay borrowers money. Banks typically make most of their profits by charging interest on loans, so this would cut into their ability to earn money from net-interest margin.

Credit interest is determined by an individual consumer’s credit score, but the fed funds rate does play a role in how much interest banks and credit card companies like AXP can charge. And credit companies like AXP also have ties to small and large businesses.

The Fed’s balance sheet has now ballooned to nearly $7 trillion and is likely to climb to or above $10 trillion over the next year according to some estimates. The central bank has plenty of options to stimulate the economy, but the uncertainty around negative rates is enough to keep investors away from stocks like AXP.

First-Quarter Earnings a Sign of Things to Come

When AXP reported earnings in April, it posted a 76% drop in profits from the same time last year. The company set aside over $2 billion to deal with losses from the effects of the pandemic, but being prepared may not be enough of a reason for investors to push the stock higher.

According to MarketWatch, the company reported an 8.8% drop in U.S. card-member loans from March to April. AXP is also dealing with more small business loan delinquencies, and that isn’t likely to get better, even if the economy fully “reopened” tomorrow.

In the chart below, you can see that AXP’s 50-day moving average has acted as resistance a few times in late April and early May. Its 50-day moving average is trending lower, and I think the stock price will follow it down.

Daily Chart of American Express Company (AXP)  — Chart Source: TradingView

Traders don’t need to buy an option with a strike price close to AXP’s current price to profit from this trade. Options that are further out of the money are less expensive, but they can gain value as the stocks fall.

I’m recommending a put option with a strike at $65 because AXP’s bottom in the March crash was just above that level. That means it’s one of a few places the stock could retest for support in a selloff.

Buy to open the American Express Company (AXP) July 17th $65 Puts (AXP200717P00065000) at $1.95 or lower.

 

InvestorPlace advisor Ken Trester also brings you Power Options Weekly, which delivers 5 new options trades and his latest trading advice to you each Friday. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.


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