Big-Money Trader Sees Boom or Bust for Bank Stocks

Hey Traders,

Rising yields and optimism about the post-pandemic reopening have largely boded well for bank stocks lately, with the Financial Select Sector SPDR ETF (XLF) just off multi-year highs.

However, at least one customer made about a $2 MILLION bet on a big move for XLF shares in the next couple of months — and stands to make money whether the fund assails new heights or suffers a healthy pullback.

XLF closed at $34.21 on Tuesday — dropping slightly from Monday’s peak — and has practically doubled since its March 2020 lows, really gaining steam after taking out its February 2020 highs in the $30-$31 region.

XLF chart since 2011

And it looks like that big option better expects more volatility over the next couple months, opening 9,000 long strangle positions, according to Trade-Alert and confirmed by my inside sources on the floor.

What does that mean?

A long strangle is a two-legged option trade that can profit on a big move from the underlying in either direction. It consists of buying a call option, and simultaneously buying a lower-strike put option.

In the case of the bank ETF, the trader bought the at-the-money (ATM) May 34/35 strangles for $2.32 apiece.

The trader will begin making money if XLF does one of two things before May options expire:

  1. Falls below the $31.68 level, which is the 34-strike put less the $2.32 paid to open the position, or;

  1. Topples the $37.32 level, which is the 35-strike call plus the $2.32 paid for the spread

Obviously a move above that upper breakeven would represent new-high territory for XLF, while a breach of the lower breakeven would put the ETF back in territory not charted since early February.

The higher or lower the shares go beyond either of those breakeven levels before the options expire, the more the strangle buyer stands to make on the volatility play, as at least one of the options will be in the money (ITM) enough to offset the losing option.

P/L graph for an XLF May 34/35 long strangle

The worst-case scenario for this trader is if XLF becomes glued to the $34-$35 neighborhood over the next several weeks. 

A close between these strikes would mean BOTH legs are out of the money (OTM), and he or she could stand to lose most or all of that $2M investment.

As far as implied volatility (IV) goes, it’s certainly been dropping for bank stocks — not uncommon when shares are on the rise — but still remains above pre-pandemic levels, as evidenced by the CBOE Equity VIX on Goldman Sachs (VXGS):

So, why would this trader expect a big boom or bust for banks?

There could be several motives for the long strangle, including today’s Federal Open Market Committee (FOMC) decision. The central bank kicked off its two-day policy meeting yesterday, and hints of rising interest rates could certainly be a catalyst for XLF.

Beyond that, perhaps the trader is expecting big business from the stimulus crowd, with many Americans receiving the latest round of Uncle Sam bucks this week … 

But perhaps the investor is playing a longer game, so to speak, and rolling the dice that the next round of big bank earnings — expected in April — will be a volatility catalyst for the ETF. Those May-dated options certainly encompass that time frame.

Personally, I like XLF a lot,  even at these highs.  With all the earnings,  if I was going to piggy back this trade I might simply buy calls.

The XLF April 35 calls (which has ALL THOSE EARNINGS) costs only about .55. That is really inexpensive exposure to upside in the financials.

Your Only Option,

Mark Sebastian

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