BigTrends

I don't consider myself an expert on global macro economic news, but there is an interesting event coming up which may influence the markets quite a bit.  The bi-annual G20 Summit is coming up June 26/27 in Toronto.  We've heard rumblings about European bankers working on their growing debt and currency problems (Hungary is the latest to be shook).  Also talk about President Obama trying to push through Financial Reform before this meeting.

What I envision is that right before this meeting of Heads of State, European bankers may unveil some sort of large bailout/restructuring type of package.  Whether this package is fiscally good or not or solves problems really isn't the issue here.  What is important is the market's reaction.  And based on how the market has reacted to important news recently, which I would call reacting in an "obvious" fashion after the news breaks -- I would bank that the market would initially rally on this type of announcement.

By "obvious" I mean that we've been seeing a short-term rally on perceived good news and the reverse for bad news.  However, the drumbeat of bad news from all over the world will continue (aftershocks of the global financial crisis will continue, possibly for years).  So after a runup whenever good news comes that may last several days -- be then prepared to put on Short and Put positions, because the technicals and fundamentals indicate that rallies will be reversed back to the downside.

I don't usually focus much on the fundamental movements of stocks as it relates to my trades.   However,  I take notice when someone who claims to 'move markets' speaks up and makes a bold statement.  I've never met Dick Bove of Rochdale Securities, a well-respected banking analyst who covers many of the bigger names in the space.  He recently penned an article saying that big banks (BAC, JPM, C, WFC and others) can potentially quadruple in 2-3 years.  Well, that timeframe would be about right for that kind of move, yet I had to think about this a moment.  Wasn't it last year these banks were SELLING tons of shares to raise capital, and eventually pay back the TARP?  I looked at market caps for just those four banks, astonished to see how big they already were, but not surprised after the massive dilution in 2009.  So, let's take them 1 by 1:

C - current mkt cap is 116 billion, a quadruple puts the stock at 16 and the mkt cap at 460 billion, more than TWICE that of AAPL.

BAC or JPM -  current mkt cap is 178 billion, a quadruple puts the stock at 72 (JPM 160)  and a market cap of 700 billion, more than TWICE that of XOM.

WFC - current mkt cap is 161 billion, a quadruple puts the stock at 120 and a market cap of 640 billion, or more than TWICE that MSFT.

Think a moment about this.  Banks still stricken with bad mortgages on the balance sheet, write-offs to capital.  They have this kind of earnings power?  Again, I don't know Bove nor do I question his experience or motivation, but it seems to me this kind of prediction is outlandish and reminds me of the Dow 36,000 call just 10 yrs ago.   Are these banks really worth MORE than those companies above?  And if so, do they deserve to be among the most powerful in the world when it's clear the interest rate cycle may be turning, which squeezes profits?

Another example of being careful what/who you listen to. 

This is just TOO MUCH.  Obama wants to slap the banks silly once again, this time taking away their ability to trade prop desks and invest/own hedge funds.  Are you kidding me?  Take away the lifeblood (yes, more than transactions) of these traditional iBanks, and what do u have left?  Let me get this straight...these are public companies, right?  And they 'normally' use private money to create capital?  Now they cannot use private capital (TARP money was paid back, remember?) for trading purposes?  This smacks of a social terror we should all fear, nevermind the cap on compensation issue, which is also something out of socialist playbook.  Right before our eyes the very freedoms our country were born with are being stripped away, one by one.  Without regard for the common good.  Are the banks the cause of the recent problems, or just the effect?  I think more of the latter than the former, but regardless of my view this is just plain wrong.

What do we have, three years left on this term?  Perhaps the outrage of the American people will signal a revolt that may turn his views 180 degrees.  As an optimist, I'm hopeful....as a realist, I'm doubtful. 

Following yesterday's blog entry where I mentioned that the Bank Index (BKX) was looking strong following a long period of stagnation, we saw a big spread trade on the BKX today.

According to livevolpro data, there was a spread that traded 3880 times on the ISE exchange on the BKX index at around 2:45 pm est today.  This was a horizontal calendar spread with the January 45 Call and the February 45 Call, with the BKX around 45.30 at the time.

Based upon the prices that the spread was done (0.96 on the Jan Call, 1.91 on the Feb Call), it looks to me like this large trader Bought the Jan Calls and Sold the Feb Calls.  The mid price on the Jan Calls was 92.5 cents and for the Feb Calls it was 1.95.  This makes the spread worth around 1.03 at the time, and they look to have sold it for about 0.96 net.  They gave the Market Makers around 0.07 worth of "edge" based on these approximations.

What does this Calendar Spread look like on a Profit/Loss Graph?  Well, this is a Long Gamma, Long Theta, Short Vega trade assuming this is a standalone Horizontal Calendar Spread.  Remember, these January options expire on the 15th -- they are paying time premium on the January Calls, which were 0.30 in the money at the time (therefore 0.66 time premium/volatility).

Considering the Long Gamma/Theta & Short Vega, it looks like they need the stock to move quickly.  A rise up would be the best case scenario, because then Implied Volatilty/Vega would go down (usually when stocks rise, option volatility drops).

For example, using OptionVue, if the stock remained flat at 45.30 and volatility also flat through Jan 15th Expiration, this position would lose around $270k.  This is due to the rapid decay to 0 in the time premium in the Jan Calls, while the Feb Calls will still hold value.  However, if the BKX rallies to 47.5 on Jan Expiration for example, this position may gain around $40k.  And IF volatility also drops 5% on the options, you then are up to a theoretical $116k profit.  On the downside, if BKX drops to 42.5 on Expiration, this makes a theoretical profit of $39k with flat volatility.  However, if volatility then rises 5% (usually implied volatility rises when a stock drops), it turns into a 39k LOSS.

You can see that these horizontal calendar spreads are fairly complex just as a standalone position.  There also is the possibility that this is a hedge or combination with another position on the BKX, its options, or other indexes, ETFs, or stocks.

It will be interesting to see how this trade (based on the information we have) plays out. 

 

 

The Banking sector, which has been lagging for months now (I've previously commented on its underperforming range) has shown some interesting signs of strength thus far in 2010.  Take a look at the chart of the PHLX Bank Index (BKX) below:

BKX Daily Chart


You can see that the recent move higher has sprung Percent R and Efficiency Ratio to levels not seen in some time.  Additionally, the slope of their upward spikes is impressive.

Bank sector should be considered for a momentum upside play ... longer-term fundamentals remain iffy, in my view.  Additionally, keep in mind that Percent R has not yet broken 80 on the BKX Daily Chart, which is a key bullish threshhold in our analysis.  Also, we are right at the Top Acceleration Band (purple lines), which is also a key technical area.

The Bank Sector (and larger Financial Sector) has often led the market in both directions over the past few years.  Recently, we've seen the Bank Group break down significantly, underperforming most other market groups.

If you examine the chart of the PHLX Bank Index (BKX) below, you can see that we have broken down below the recent slightly uptrending range.  In addition, Daily Percent R has plummeted to bearish territory.

Bottom line, I'm concerned that weakness in the Bank Sector is telling us something ... and may spread to other Financials and the overall market, leading to continued near-term weakness in the major indices.

BKX Daily Chart

We've seen over the past couple of weeks some great strength, and even yesterday's bullish close was another reason we can 'trust' this market.  Sure there is uncertainty out there, namely this stress test stuff.  But that uncertainty will be removed in a week or so, and really what don't we already know?  If a bank passes the test they are safe, if a bank fails they will get more capital. 

Banks are blowing up left and right here, gains from the previous six week are vaporizing in minutes and hours....akin to taking the elevator up and the window down.  Are these still trading vehicles, or true investments?  It's clear the former is true for now.  A big move higher in volatility yesterday was a reminder that the bear market still lives on.

As I blogged here on Friday, a bit of 'payback to the bulls' was expected.  Notable was the bloated McClellan Oscillator and weaker volume coming in as the market rallied.  The timing is not always perfect, but in this case it worked out.  I suspect more weakness could come into play here as the ultras define the rest of the day (shorts).  Oil is really getting drilled here and the dollar strength puts a cap on commodities.  Banks are also weak, but after last week's drive it's expected.  We'll have to assess over the next few days whether the next cycle is down.