Strangling U.S. Banks
Options News by Better Trades
Nationalization has been the hot button word floating around Wall Street of late
as U.S. companies flirt with declining stock prices and insolvency.
Specifically, bank shares are rising and falling in the oceanic storm of financial
instability, providing a fantastic investing opportunity for options traders.
Intraday on Tuesday, February 24th, shares of Bank of America (BAC) jumped over
16%, JPMorgan Chase (JPM) climbed 6%, Wells Fargo (WFC) rocketed up 15%, and
Citigroup (C) soared 14% in the wake of Fed Chairman Bernanke's testimony before
the Senate Banking Committee. As recently as Friday, the same bank stocks were hit
with declines of 3.6%, 3.4%, 9.2%, and 22.3%, respectively.
By constructing long straddles or strangles, options traders can capitalize on the
monumental swings in bank stocks that are taking place on a daily basis.
A long straddle is the purchase of a put and call option with the same
exercise price and expiration date. In the case of a long straddle, the investor
hopes to profit from a large price move.
A long strangle involves buying a call and put on an asset with the same
expiration while the call exercise price is greater than the put exercise price.
Conversely, a short strangle or straddle is the sale of a put
and call. Here, the investor is betting on a decrease in volatility, anticipating
that the options will expire worthless.
Since straddle/strangle positions involve in-the-money or at-the-money purchases,
the cost of entering such a position is relatively more expensive than purchasing
out-of-the-money positions. There is also risk exposure to a loss if volatility
decreases.
Normally, straddle/strangle positions are optimal when there is a pending news item
such as earnings. But with market volatility soaring to unforeseen heights over the
past few years, options traders are cashing in on regularly turbulent market
conditions.
Beta coefficients of major U.S. bank stocks are operating at historically elevated
levels. Beta describes a stock's expected return as it correlates to broad-market
returns. Searching out higher beta banking stocks effectively scans the market for
long straddle or strangles to capture potential returns from large price
fluctuations.
A broader measure of volatility, the Chicago Board Options Exchange Volatility
Index, or VIX, is resting comfortably near 46 as of February 24, 2009, signifying
an elevated level of volatility - but nowhere near the historic highs reached back
in October. A higher VIX means costlier option prices to compensate for increased
volatility.
Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, US Bancorp, SunTrust Banks
(STI), The Bank of New York Mellon (BK), and PNC Financial (PNC) are potential
straddle or strangle targets. These U.S. banking stocks have been the primary
targets of short sellers since October of 2007 because of their market position and
exposure to toxic mortgage backed assets. Short pressure coupled with ephemeral
relief rallies have put the share prices of these banks in constant flux.
|
