This article was last updated on October 23
Financial stocks have taken a battering over the last week with steep falls across the board, including the big banks such as Citigroup (C), Bank of America (BAC) and JP Morgan Chase (JPM) which have all fallen more than 25% to record lows. The reasons behind the falls are primarily due to a re-emergence of the credit crisis as it becomes evident that a number of the larger banks will need more federal cash injections (or yet another bailout) to stay liquid. Bank of America, which seemed to be amongst the most well capitalized, may need up to another $80 billion and Citigroup is to be split-up in order to survive. This and other grim news (like dividend cuts) on a number of financials has dominated the business news of late and placed continued pressure on stock prices.
The other big the cause for the sharp stock price falls are pure panic as investors run for the doors fearing the collapse of our big financials, despite government assurance to guarantee and/or buy the “toxic” assets ts held by these institutions.
In panic comes opportunity
If the banking system, in spite of the governments explicit guarantees, is actually on the brink of collapse then god help us all. However if stocks have been oversold due to investor panic and over reaction (which is my view) then we could have an excellent trading opportunity on our hands. Further I think President Obama will soon get approval for his stimulus package and remaining TARP funds, which should boost stocks, including the financials.
One option to trade the “panic” is to buy the stock or underlying call option of the big financials that are most under pressure. However this creates too much company specific risk. I think one big bank may go under, but unlikely all will, so a diversified play is a better bet. Also, options are trading at a big premium now and due to the unknown time frame for a financial sector recovery, they are not the best vehicle for the trade I am proposing.
To get the required diversification, you could but the underlying financial index spider exchange traded fund (ETF) – XLF – but at $8 and change it is expensive. I prefer using the pro shares ultra long financials ETF – UYG. This is currently trading at about $2.75 and offers double the exposure of an upward move in the Dow Jones U.S. Financials index (off course it also magnifies the losses if the index continues downward). Because it is an ETF you can trade it like a stock (use Zecco for $0 trades) and does not suffer the option time decay problem.
Looking at the chart of UYG over the last 6 months you can see the volatility and why the inevitable upward bounces (bottom circled in red) presents a good trading opportunity now. There is a good chance the stock could jump 50% or more in a few days (at which point I will sell), though I am prepared to hold for up to one month. I am also confident that UYG is close to an interim bottom, but my stop-loss is $1.20 – just in case.
All this being said, this is a risky trade and definitely not a buy and hold play. I am going to put $2000 into this trade today, and see what happens over the next few days.