Bank Heroes and Bums – Playing Wells Fargo (NYSE: WFC) and Banco Santander (STD)

We received a great deal of correspondence over last week’s recommendation to take profits in all equity positions, nearly all of it positive.  Still, we’re trying to move on.  In this business, you’re only as good as your last call; hero one day; bum the next.  And arrogance is the undoing of every successful trader.

In an effort to avoid that, we’re following fast with the following recommendations regarding open options positions that are currently profitable.  Please pay close attention to the details.  We had a close friend last week who sold a put position we recommended purchasing, and took a loss of several thousand dollars when it should have been a profit.  The devil – and the profit – is always in the details.

But before we get to those recommendations, a word on recent market gyrations.  Take a look here:

To sum it up:

First, we don’t believe in four day market corrections (see in red, above).  Good luck to you if you do.

Second, volume on both the down and upside was high, but not unlike anything we’ve seen in the last six months.  A genuine correction will scare lots more money out of weaker hands.  This ‘correction’ has scared nobody as yet.  Despite the alleged intraday computer glitch and 1000 point DJIA fall, the amount of dollars that actually jumped from equities over this whole four day event was infinitesimal.

Third, stock market corrections generate meaningful, lasting mainstream media attention.  This event was a media non-event.

In short, prepare for more, and expect significant resistance at Dow 11,000.  For those interested in taking on short positions, that level would present a logical opening.

Now back to our regularly scheduled program.

Unwinding Your Options Trades

1.    In our April 11th instalment, Technical Ponderings on Gold and a Two-Way S&P 500 Trade, we recommended two zero premium trades to take advantage of sharp market moves in either direction.  We suspected a selloff was at hand, but wanted to be covered in the event of an upside move as well.

One side of the trade is now worth closing.

If you put on the SPY-XLY trade, you now have roughly $90 profit per pair traded.

Because you bought (in equal numbers) the XLY September 34 CALLS and sold the SPY September 129 CALLS, you must now sell the XLY holdings and buy back your SPY options.

2.    On 26 April, a mere two weeks past, we recommended you purchase long dated treasury options (January 2012) on the Barclays 20+ year Treasury Bond Fund (NYSE:TLT) for $5.15 (90 strike).  Those 90 strike options have soared in value and are trading now with a spread of $7.70-$8.55.

It may be early in the life of this option, but we’re closing out with a minimum of 50% profits in two weeks and not looking back.  We may set the trade again in the future, but we also recognize the possibility of a continued bounce in yields if the market feels last week’s selloff was overdone/premature/etc.  As we stated last week, you can never go broke taking a profit.

Was the Bond Surge Overdone?

Because we recommended Leaps Calls on the TLT, we’ll now use it as a proxy for long term Treasuries.  Yes, there are a number of other vehicles that may or may not be better representatives of the long end of the bond market, but Barclays’ TLT issue is where most of Oakshire’s clientele seem to flock with their long bond trades.

Here’s a chart of TLT for the last six months:

The chart shows a security that traded multiple standard deviations outside its norm in the last few trading sessions – along with volumes that were four times the average daily truck in the stock.

The move took the shares sharply above their long term moving average (in yellow) before snapping back to that line then moving lower.

The current gap down will have to be filled, however, and we’re confident it will be in the weeks ahead.  The long bond is in bullish mode at present – despite the current profit taking.

Keeping with Current Themes

We are still bullish on the stock market going into 2011, but we’re out for the time being on the notion that the Dow and S&P 500 still have some falling to do.  Fibonacci counts on the two indexes show the Dow plumbing one of two possible bottoms at 9436 or 8311.  See the following chart for a visual reference:

As we’ve opined repeatedly in the past, everything depends on sentiment.  If the market puts the fear of heaven into investors at 9400, then that will be the bottom.  If it takes another 1000 points of downside to get them feverish, it will be 8300.  Our strong suspicion is that the latter, lower level will prove correct.

We’ll be monitoring all the usual sentiment suspects for signs of a turning point.

This Week’s Trade

Our trade for the week is predicated on a continuation of the same themes we’ve been repeating over the last few months.  They include dollar strength, steadying confidence in the American economy, and a tagalong effect for Western Europe as its current woes subside.  Europe’s weekend bailout plan, by the way, did almost nothing to strengthen the Euro.

With that in mind, we’re focused on Europe’s financial sector, because it’s there we sense the greatest current danger.  European financials will end up taking the worst hit if worries persist regarding Mediterranean fiscal folly.

Here’s the way the continent’s financials have behaved over the last two years:

As you can see, the financials have closely tracked movements in the Euro.  We expect they will continue to do so.  That means another hard, ‘catch-up’ fall for the financials (in blue, above) could be in the offing.

The Bums and the Heroes

Perhaps the worst of Europe’s banks is Spain’s Banco Santander S.A. (NYSE:STD), which not only has an unfortunate ticker symbol, but also has significant exposure to PIIGS debt.  This week, CDSs on the bank widened to the same level as those of Spain proper, indicating significant fear on the part of insurers as to the creditworthiness of the company.

Shares in the bank are down over 40% on the year.  Here’s the chart:

Irrespective of the reaction bounce on the heels of the EU bailout package, we’re confident that Banco Santander is in a more troubled state than American banking giant Wells Fargo (NYSE:WFC), whose chart looks as follows:

For this reason we are buying Santander PUTS and selling Wells PUTS – same value on both – and executing a zero premium trade.  We’re using different months (due to availability issues), but the trade is far enough out that it shouldn’t make a difference.  We will profit off a widening spread between the two as markets fall.  And the trade costs you nothing outside of commissions to initiate.

Wall Street Elite recommends buying equal numbers of STD September 12.50 PUTS for $2.30 and selling the WFC October 31 PUTS also for $2.30.

With kind regards,

Hugh L. O’Haynew