Financials have been stampeding higher, and some options traders are joining the herd.
The KBW Nasdaq Bank Index was on a roll before yesterday, having risen in 10 of the previous 13 sessions. Like a long-jumper with a good running start, it launched to its highest level in almost seven months as investors giddied-up for potentially sweeping tax cuts.1
Many names were active, but the biggest transaction hit in Citigroup (NYSE: C). In a single second shortly before lunch, a trader bought 50,000 January 2019 95 calls for $1.28 and sold 100,000 January 2019 100 calls for $0.77. Most readers probably know that owning calls fixes the price where you can purchase a security. Selling them is just the opposite, earning income but also creating an obligation to deliver shares if a certain level is reached.
Ok we knew that from the great videos on E*TRADE’s website. But what’s with the blocks of 50,000 and 100,000? Is that a 2-by-1 “ratio” spread? Indeed it is, and this is what it seems to mean:
- The investor received a credit of $0.26 per share, or $650,000 up front. But that’s chump change compared with the $12.5 million they’ll reap if C closes at $100 on expiration: That’s 25,000 contracts X 100 shares per contract X the $5 per share they’ll get if the stock closes at $100 on expiration. But once triple digits are reached they’re effectively short 5 million shares.
- That’s obviously a huge risk by itself, but what if this investor already has 5 million shares? Then they’ll simply deliver that stock, and enjoy an extra pay out in the meantime.
- C rose 1.89 percent to $72.28 yesterday, but traded at much higher levels back before the 2008 financial crisis (factoring in a reverse stock split early this decade). Was Wednesday’s option trade the work of someone who’s been trapped in a losing position all that time? There’s no breakeven on the options because they took in a credit, but they would have downside risk on the shares.
- Expiration, by the way, is 15 months in the future… reminiscent of another long-term trade in United Parcel Service (NYSE: UPS).
Source: OptionsHouse by E*TRADE.
C had plenty of company in the session. Alabama-based Regions Financial (NYSE: RF) drew shorter-term bullish bets with 17,000 October 17 calls purchased for just $0.05. Deutsche Bank (NYSE: DB) also had 18,000 November 16 calls bought, mostly for $0.95. Then there’s Synchrony Financial (NYSE: SYF), with over 2,400 October 31.50 calls crossing the screens for $0.55.
Aside from tax cuts, is anything else driving the sector? Plenty, say the bulls. Just take Janet Yellen. Back in June the Fed chair took the training wheels off the sector by allowing dividends to return, and this week put the pedal to the medal by talking up interest rates.2 Nothing wrong with that if you lend money…
But there’s more at a fundamental level. C, for instance, now trades at roughly book value and has a Tier 1 capital of about 15 times that. Last decade it traded for twice book and had half the capital ratio.3 That suggests it’s both cheaper and may be safer.4 Earnings are due soon as well.
Bottom line: Financials have been accelerating and yesterday traders banked on the move continuing.
1. Reuters: Trump proposal slashes taxes on businesses, the rich amid deficit worries. 9/27/17.
2. Reuters: Fed gives big U.S. banks a green light for buyback, dividend plans. 6/28/17. RTT News: Yellen Hints At Rate Hikes. 9/26/17.
3. Financial ratios are based on Bloomberg data.
4. For more on financial ratios, see: Federal Reserve Board of Governors: Risk Management and Capital Adequacy of Exposures Arising from Secondary Market Credit Activities. 7/11/97. Investopedia: Tier 1 Capital. Investopedia: Price-To-Book Ratio - P/B Ratio.