Wednesday, August 24, 2011

US Banks - Are They Collapsing?

I posted this to a few days ago, thought it might be an interesting perspective. It's a continuation, or expansion really, of a few posts I wrote on BAC and USB.


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Source: (OptionsProfits)

Let’s talk about banks. Not loans, and mortgages, ATMs and tellers, ‘n stuff. Let’s talk about the possibility of catastrophic failure – the possibility that banks return to levels not seen in three years. Not seen in 15 years. Maybe, not seen ever.

Why? Is it because I think that’s gonna happen? No. It’s because the market is starting to price that possibility – and I don’t mean by year end, I mean in, in some cases, within a few weeks.

Let’s start with a composite stock chart of BAC (red), WFC (blue), C (yellow), JPM (green) and a wall street darling, USB (orange).

We can see that BAC and C are performing the worst. I wrote a fairly detailed article about BAC on 8-9-2011, where I demonstrated, through some back of the envelope math, that the market was essentially pricing a 1/7 chance that BAC stock goes worthless by Jan 2012. But as we can see in the chart above, I was picking the worst performing company in a poorly performing and fear drenched industry. Just rattling the cages, right?

Ok, let’s take the opposite approach and look at USB. The best performing of the group, almost unched over the last two years. There was an interesting article through the New York Post praising USB’s CEO, Richard Davis. The article is titled, “Small bank giant: US Bancorp outperforms all Wall St. titans,” and can be read in entirety here:

Here are some snippets:
Forget JPMorgan Chase’s Jamie Dimon. Wall Street has a new golden boy: US Bancorp’s Richard Davis.

At a harrowing time for financial firms, when most banks find themselves battered and bloodied due to a raft of new regulatory changes under Dodd-Frank and an economy on the brink of a second recession, Davis’ bank is separating itself from the pack.

Indeed, net income in the second quarter for the Minneapolis-based bank was up 57 percent to $1.2 billion, compared to $766 million in the same period a year ago.

And so far the bank, which is the fifth largest in the nation, is No. 1 in terms of performance, or return on equity -- one measure of performance.

Cool, that bank is doing well. No worries there, right? Let’s start with some options analysis. First, the Livevol® Pro Symbol Summary. USB is trading $20.80, up 1.2% with IV30™ down 7.6% today.

Now, let’s turn to the Skew Tab.

We can see a rather pretty skew shape for both months -- consistent and smooth. I don't like either of those adjectives when looking for a skew trade, but that's what we got. Obviously, the front is elevated to the back (red line is above the yellow line).

I believe the next earnings cycle for USB will be after the Oct cycle (i.e. in Nov), so owning Oct doesn't own an earnings report. For what it's worth, the Dec cycle is priced below both Sep and Oct (in terms of vol) for you vega buyers out there. The point here, the skew is not crazy out of line to the downside (or upside) – everything looks “nice and neat.” Even, “orderly.” Orderly…

Now we can turn to the Charts Tab (below). The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20 - blue vs HV180 - pink).

We can see the almost obligatory stock drop, vol spike and implied trading below short-term realized vol. This is how a number of stocks look right now on the vol side. So far, nothing looks too worrisome – it’s a down market, no big deal…

But, here's where it gets a little more interesting -- if for nothing else, from a market sentiment point of view. Let's start with the Options Tab (below).

Note the 15 strike puts in Sep. Those are priced at ~87 vol, or ~$0.16 fair value. And why does that matter? Well, the 52 wk range in USB is [$20.15, $28.66]. Keep in mind, those Sep 15 puts are winners to the longs on expo "iff" USB stock dips to $14.84. Yeah, that's a lot lower than the 52 wk low. In fact, USB hasn't been below $20 in more than 2 years. I've included a long-term stock chart for USB from Yahoo! finance, below.

I've drawn a line at $15. The only time USB breached that level was at market bottom in 2009. Before that, it was September... of 1997...

So we have the best performing bank of the big five, with a newly touted “Golden Boy” CEO (granted, he hasn’t appointed himself, so let’s not pile on him for something he had nothing to do with). And even in this stock, the options are pricing a realistic possibility that the stock his 2.5 year and maybe even 15 year lows… by September 16th.

The point is, the financial companies, banks in particular, have near-term options priced for a legitimate possibility (or fear) of a drop akin to the 2009 massive market bottom -- which in some cases were bank stock levels in the late 90's.

So is the sky falling? I dunno – you tell me. For those that are willing to bet that it isn’t (at least in the next four weeks), “normal" calendar spreads (for example) are on the board with the possibility of adding naked short puts at levels like... well, like $15 for USB.

What about the worst performing of the group, BAC? The Sep 3 puts are priced at $0.07 x $0.08. When was the last time BAC traded at $3. Drum roll please…

… Never.

Is it possible that it will? Yeah, it is, and the option markets reflect those odds in absolute terms. Just out of curiosity, if the sky really does fall, what do we see when we look up?

This is trade analysis, not a recommendation.

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  1. great article ophir. love reading your articles. Just wish i had the courage to trade these options.

  2. Thanks, Neil. At the very least, it's really interesting to just watch...