Here's another thought: why not look into an index or index-based ETF or one that tracks the financial services sector at large? An index that follows the banks only is KBW Bank Index (BKX), and a more broad-based financial services product is the Financial Select Sector SPDR Fund (XLF). Most of the top holdings in XLF are bank stocks, but it also includes some of the brokerage stocks like Merrill Lynch and Charles Schwab.
KBW Bank Index (BKX)
The BKX is a European-style, cash-settled index that only consists of banks (see a holdings list below); as of this writing BKX was trading around $90 per share with option contracts in 2 ½ point-wide strikes. A potential downside to BKX options is that the average volume of contracts traded is only 5,955. The low volume numbers sometimes causes the spreads between the bid and ask to be wide at times. This means a larger percentage of your investment capital may be spent getting in and out of the trade.
Avg Option Volume 5,955
Open Interest 161,210
Avg Open Interest 132,210
Implied Volatility (30 day) 36.84%
Historic Volatility (30 day) 39.70%
Financial Select Sector SPDR Fund (XLF)
XLF does include both bank and a few brokerage firm stocks, but XLF offers a decent approximation of the bank sector as long as you keep this blend of stocks in mind. Both the ETF shares of XLF and options based on it are highly liquid; in fact, its option strikes are in one-point increments and the contracts trade in pennies. For an ETF trading around $28 per share, it's certainly affordable - more affordable than trying to cover the whole sector by trading multiple bank stocks. Another proof of its liquidity is its average volume: over 355,079 contacts per day trade in this underlying.
Avg Option Volume 355,079
Open Interest 6,960,675
Avg Open Interest 5,730,767
Implied Volatility (30 day) 34.96%
Historic Volatility (30 day) 37.56%
Bullish or bearish?
If you're bearish on the financial services sector, you can consider buying an XLF or BKX put over the time-period when you think the bottom might hit. On the flip side, if you're bullish and looking to buy in at the bottom, you can pick up some shares of XLF and perhaps buy a protective put to protect yourself if your timing to get in was not quite perfect. Another bullish strategy would be to buy a call option in the BKX.
Either way, it's probably easier to trade your opinion on a single sector-based ETF or banking index versus trying to pick the one stock that you think will bounce back and it turns out that is the one that did not make the cut and went under. For a closer look at XLF and other sector-based ETFs, login to your TradeKing account and head to Quotes + Research > ETF Center.
Step off the beaten path?
If you do think you can pick the one financial services stock that can beat the sector, an interesting way to trade and offset some risk is to do what is called a pairs trade.
This strategy consists of matching a long position with a short position in two securities of the same sector. This creates a hedge against the sector and the overall market that the two securites are in. You're simply hoping the long security outperforms the short security. Obviously, you'd like to choose two stocks that are closely correlated.
Here's a fairly simple example: you could decide to buy one of the top holdings in XLF, and then sell the XLF short. This way if you're able to pick the "best" stock in the sector, it may outperform the ETF if the sector does come back. On the other hand, if you're wrong and the market continues to decline, your short position in XLF may offset some of the losses in the individual stock position.
Beware: if you're not a great stock picker, you might be better off not trying a pairs trade. It's when you happen to pick the one stock in the sector that underperforms - that's where the most risk occurs. Conceivably you might lose on both the long position and on the short position.
This quick discussion got me thinking about a possible series of posts about ETFs and indexes. Not everyone realizes how many ETFs and indexes there are out there, representing industry sectors like financial services and plenty others. It can also be handy to keep these products in mind to hedge your other positions. Keep your eyes peeled for more on this topic in 2008.
And with that, happy holidays from all of us at TradeKing!
Regards,
Brian (OG)
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Fund Name: | KBW Bank Sector Index |
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Ticker Symbol: | BKX |
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Holdings | As of 12/20/2007 |
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Ticker | Company Name | % of Total Assets |
JPM | JPMorgan Chase & Co | 10.08% |
WFC | Wells Fargo & Company | 8.54% |
BAC | Bank of America Corp. | 8.30% |
STT | State Street Corporation | 5.96% |
C | Citigroup | 5.87% |
NTRS | Northern Trust Corp | 5.74% |
USB | U.S. Bancorp | 5.61% |
BK | Bank of New York Mellon | 5.55% |
PNC | PNC Financial Services Group | 5.40% |
STI | SunTrust Banks Inc | 4.26% |
WB | Wachovia Corp. | 3.74% |
BBT | BB&T Corporation | 3.53% |
RF | Regions Financial Corporation | 3.46% |
COF | Capital One Financial Corp | 3.08% |
FITB | Fifth Third Bancorp | 3.01% |
MTB | M&T Bank Corporation | 2.75% |
KEY | KeyCorp | 2.47% |
CMA | Comerica Inc | 2.46% |
NCC | National City Corp | 2.38% |
ZION | Zions Bancorporation | 2.13% |
WM | Washington Mutual Inc. | 1.87% |
MI | Marshall & Ilsley Corp | 1.35% |
PBCT | People's United Financial Inc | 1.27% |
HBAN | Huntington Bancshares Inc | 1.18% |
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Fund Name: | Financial Select Sector SPDR Fund |
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Ticker Symbol: | XLF |
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Holdings | As of 12/20/2007 |
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Ticker | Company name | % of Total Assets |
BAC | Bank Of America Corporation | 8.16% |
C | Citigroup Inc | 6.60% |
JPM | Jp Morgan Chase & Co | 6.51% |
AIG | American Intl Group Inc | 6.46% |
WFC | Wells Fargo & Co New | 4.51% |
GS | Goldman Sachs Group Inc | 3.65% |
WB | Wachovia Corp New | 3.27% |
AXP | American Express Co | 2.68% |
BK | Bank Of New York Mellon Cor | 2.47% |
USB | Us Bancorp Del | 2.42% |
MS | Morgan Stanley | 2.40% |
MER | Merrill Lynch & Co Inc | 2.09% |
MET | Metlife Inc | 2.00% |
PRU | Prudential Finl Inc | 1.87% |
CME | Cme Group Inc | 1.65% |
FNM | Federal Natl Mtg Assn | 1.54% |
TRV | Travelers Companies Inc | 1.52% |
LEH | Lehman Bros Hldgs Inc | 1.47% |
STT | State Str Corp | 1.37% |
AFL | Aflac Inc | 1.31% |
ALL | Allstate Corp | 1.30% |
HIG | Hartford Finl Svcs Group In | 1.23% |
NYX | Nyse Euronext | 1.02% |
SCHW | Schwab Charles Corp New | 1.01% |
PNC | Pnc Finl Svcs Group Inc | 0.98% |
STI | Suntrust Bks Inc | 0.95% |
LTR | Loews Corp | 0.94% |
CB | Chubb Corp | 0.93% |
FRE | Federal Home Ln Mtg Corp | 0.91% |
ACE | Ace Ltd | 0.89% |
SPG | Simon Ppty Group Inc New | 0.88% |
PFG | Principal Financial Group I | 0.81% |
COF | Capital One Finl Corp | 0.80% |
BEN | Franklin Res Inc | 0.79% |
BBT | Bb&T Corp | 0.76% |
RF | Regions Financial Corp New | 0.74% |
TROW | Price T Rowe Group Inc | 0.70% |
LNC | Lincoln Natl Corp Ind | 0.69% |
PLD | Prologis | 0.69% |
NTRS | Northern Tr Corp | 0.65% |
AOC | Aon Corp | 0.63% |
FITB | Fifth Third Bancorp | 0.61% |
MMC | Marsh & Mclennan Cos Inc | 0.60% |
ICE | Intercontinentalexchange In | 0.58% |
PGR | Progressive Corp Ohio | 0.58% |
AMP | Ameriprise Finl Inc | 0.57% |
WM | Washington Mut Inc | 0.57% |
BXP | Boston Properties Inc | 0.52% |
VNO | Vornado Rlty Tr | 0.51% |
GNW | Genworth Finl Inc | 0.48% |
BSC | Bear Stearns Cos Inc | 0.47% |
NCC | National City Corp | 0.45% |
GGP | General Growth Pptys Inc | 0.44% |
EQR | Equity Residential | 0.44% |
LM | Legg Mason Inc | 0.42% |
PSA | Public Storage | 0.42% |
KIM | Kimco Realty Corp | 0.41% |
HST | Host Hotels & Resorts Inc | 0.41% |
XL | Xl Cap Ltd | 0.40% |
KEY | Keycorp New | 0.38% |
SLM | Slm Corp | 0.38% |
UNM | Unum Group | 0.37% |
MCO | Moodys Corp | 0.37% |
PCL | Plum Creek Timber Co Inc | 0.36% |
LUK | Leucadia Natl Corp | 0.35% |
HCBK | Hudson City Bancorp | 0.34% |
SNV | Synovus Finl Corp | 0.34% |
AVB | Avalonbay Cmntys Inc | 0.33% |
DFS | Discover Finl Svcs | 0.33% |
CBH | Commerce Bancorp Inc Nj | 0.32% |
MI | Marshall & Ilsley Corp New | 0.32% |
CINF | Cincinnati Finl Corp | 0.30% |
AIZ | Assurant Inc | 0.29% |
CMA | Comerica Inc | 0.29% |
ACAS | American Capital Strategies | 0.28% |
MTB | M & T Bk Corp | 0.26% |
TMK | Torchmark Corp | 0.26% |
JNS | Janus Cap Group Inc | 0.23% |
SAF | Safeco Corp | 0.23% |
HBAN | Huntington Bancshares Inc | 0.23% |
CFC | Countrywide Financial Corp | 0.22% |
ZION | Zions Bancorporation | 0.22% |
DDR | Developers Diversified Rlty | 0.22% |
CIT | Cit Group Inc | 0.19% |
SOV | Sovereign Bancorp Inc | 0.19% |
CBG | Cb Richard Ellis Group Inc | 0.19% |
FII | Federated Invs Inc Pa | 0.16% |
AIV | Apartment Invt & Mgmt Co | 0.15% |
ABK | Ambac Finl Group Inc | 0.12% |
MBI | Mbia Inc | 0.11% |
FHN | First Horizon Natl Corp | 0.10% |
MTG | Mgic Invt Corp Wis | 0.08% |
ETFC | E Trade Financial Corp | 0.06% |
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.
While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.
Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.