* Put option prices in banks become expensive-analyst
* Legislation may already be priced in for big bank stocks
* Volatility over past month in financial ETFs rises
By Doris Frankel and David Gaffen
CHICAGO/NEW YORK, June 4 Financial stocks may
face more volatility in coming weeks as a sweeping overhaul of
the U.S. financial industry looks set to pass in early July.
Options strategists say there are several strategies
investors can use to play the pending financial regulation
ranging from the conservative to the speculative.
"There has been concern that the pending congressional
reconciliation bill would have further downward pressure on the
financial sector before the fourth of July holiday weekend,"
said Scott Fullman, director of derivative investment strategy
at broker-dealer WJB Capital Group in New York.
The sector has fallen more than the broader market in the
last several weeks. The S&P Financial Index .GSPF is down
about 15.8 percent since April 14, more than the S&P 500, which
is down 10.7 percent in that time.
Volatility in exchange-traded funds that track the
financial sector also rose over the past month.
For example, the 30-day implied volatility for the XLF rose
to 34.78 percent on June 3 from 27.88 percent on May 3,
according to options research firm OptionMetrics.
The legislation is being shaped into final form by a U.S.
Senate-House panel, and with the final language in the bill not
determined, it leaves open the possibility of surprises for
To speculate or protect against a sharp decline, Fullman
recommended a 1-by-2 ratio put spread in the Select Sector SPDR
Financial fund (XLF.P). The ETF, which tracks the performance
of the financial names from the S&P 500, ended at $14.74 on
This involves buying one XLF July $15 put option and
selling two XLF July $12 put options, resulting in a total net
cost of 59 cents. The upper break-even point is $14.41, the
lower break-even is $9.59. Below $9.59, the strategy loses
money, he said.
An equity call option allows share purchases at a fixed
price up to a certain date. A put option grants the right to
sell the shares at a preset price anytime until expiration.
Brian Overby, senior options analyst at online brokerage
TradeKing in Charlotte, N.C., said put option prices in the
banks have already become "quite pricey."
"One way to lower the cost of protection is to employ a
collar strategy, a trade that can give some downside protection
while waiting for the outcome of financial reform legislation,"
With a so-called collar, an investor who owns 100 shares of
Goldman Sachs Group Inc (GS.N) can purchase a July $135 put at
a $5.25 premium. At the same time, the $150 GS July call option
is sold for $5.40. That premium received for sale of the call
would help fund the put purchase.
Goldman traded at $145.43 on Friday.
This trade limits the downside risk if Goldman shares drop
below $135. But gains are capped, since shares can only rise up
to $150 before the investor is obligated to sell the stock by
July expiration, Overby said.
PRICED INTO THE MARKET?
Victor Schiller, president of InvestorsObserver.com, an
equity options research and analysis firm in Charlottesville,
Virginia, said current bank stock prices already reflect
expectations for lower profits from the anticipated bill.
"The worst case scenario of this bill is probably baked
into the most widely-held bank issues such as Goldman Sachs,
Citigroup Inc (C.N), Bank of America Corp (BAC.N), and Wells
Fargo & Co (WFC.N)," Schiller said.
He suggested a June $35/$30 bull-put credit spread in
JPMorgan Chase & Co (JPM.N), where investors would buy one June
$30 put for every June $35 put they sell on the view the stock
does not have much further to fall by June 18 expiration.
"The stock would need to drop below $35 by June expiration
for this position to start losing money," he said.
But there are wild cards in the legislation. Key reforms
still under consideration would require reporting of
over-the-counter derivatives trades to regulators. The Senate
measure goes a major step further in requiring banks to spin
off their swap-trading units. [nN0397139].
(Reporting by Doris Frankel; Editing by Andrew Hay)