By Steven M. Sears
Financial stocks fell out of favor for many investors, but that appears to be changing.
Positioning in the options market, and recent stock market action, suggests aggressive investors are beginning to prepare for significant gains.
The optimism seems hinged on expectations that the Federal Reserve will lower interest rates as early as September. Lower rates could spark a surge of profitable business activity for banks and breathe new life into the real estate industry.
The financial sector's recent price performance has been extraordinary, though it hasn't attracted much attention. The commentariat has been overly focused on trendy issues like artificial intelligence, rate cuts, and Warren Buffett's decision to take profits on some key holdings.
Buffett recently reduced his giant Bank of America position, adversely impacting sector sentiment. Buffett is considered to have a supernatural understanding of banks and brokers, and few people ever want to be on the opposite side of his trades. Yet, the Financial Select Sector SPDR exchange-traded fund (ticker: XLF) has gained about 13% since mid-April, outperforming the S&P 500 index's gain of some 12%.
XLF's stock chart indicates the rate-sensitive financial sector has just managed to push beyond levels that historically limited gains. If XLF's tender breakout strengthens a bit more, XLF will definitively be trading at historically high levels.
Since mid-July, XLF has twice tried -- and failed -- to push above $44. The third try above $44 followed Fed Chair Jerome Powell's dovish speech in Jackson Hole, which revived bullish sentiment and seemingly put XLF into a holding pattern ahead of the sector's next major catalyst: the September 18 conclusion of the Fed's two-day rate-setting committee meeting.
To position for an XLF breakout, aggressive investors can consider a risk-reversal strategy. This entails selling a put and buying a call with a higher strike price but same expiration. The strategy positions investors to buy XLF on a pullback while participating in any gains.
With XLF at $44.80, investors can sell the December $41 put and buy the December $48 call. At $55, the call is worth $7. If the stock price is below $41 at expiration, investors must buy XLF at the $41 put strike or adjust the puts to avoid assignment. During the past 52 weeks, XLF has ranged from $31.36 to $44.82.
The December expiration was chosen to capture the September, November, and December Fed meetings. The expiration also provides time for banks and real estate firms to tell investors about whatever changes have occurred in their businesses due to lower rates.
The options market is humming with bullish trades in the financial and real estate sectors in anticipation of their resurgence. The trades would prove profitable if lower rates boost mortgage applications and refinancings.
Susquehanna Financial Group recently advised clients that an investor bought 5,000 March $49 calls on XLF that expire March 31 for 54 cents.
Another investor bought 5,000 November $15 calls on real estate services firm Cushman & Wakefield for 40 cents, likely poised for company earnings. The stock was recently around $13. The trade is significant. Cushman & Wakefield's average daily trading volume is about 96 contracts.
Meanwhile, Susquehanna advised clients that an investor closed 10,000 September $98 calls on the iShares U.S. Real Estate ETF for about $2 and bought 14,000 September $100 calls for $1.05.
When these disparate parts are synthesized, it equals this: Money, like water, flows to the lowest point. If the Fed lowers rates, the financial sector may bullishly emerge as the market's low-water mark.
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(END) Dow Jones Newswires
August 28, 2024 01:30 ET (05:30 GMT)
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