Bank Puts Fall Most in S&P 500 as Profits Reduce Crisis Pessimism: Options
The cost of options protecting against losses in financial companies is falling faster than any other industry as earnings reassure investors that banks and brokerages will avoid a repeat of 2008.
Three-month puts on the Financial Select Sector SPDR Fund (XLF) cost 10.15 points more than calls, according to Bloomberg data on implied volatility. The price relationship known as skew has narrowed 16 percent since Oct. 3, the most among nine ETFs tracking Standard & Poor’s 500 Index industries, as the gauge jumped 11 percent.
Results from Bank of America Corp. (BAC), Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM) are reducing pessimism after concern Europe’s debt crisis would spread sent price-to-book ratios on financial companies to the lowest level since April 2009. Bank shares have gained 14 percent since Oct. 3 after falling 31 percent since the S&P 500’s April 29 peak, data compiled by Bloomberg show.
“A great deal of pessimism is baked into bank-stock valuations,” Brian Barish, Denver-based president of Cambiar Investors LLC, which oversees about $8 billion, wrote in an e- mail yesterday. “Perhaps less volatility baked into the valuations is appropriate.”
About $170 billion has been restored to financial stocks in the S&P 500 since Oct. 3 on speculation Europe will find a solution to its debt crisis. The Financial ETF climbed 4.8 percent yesterday to $12.79, while the S&P 500 increased 2 percent to a two-month high of 1,225.38.
The 10 financial companies that have reported results so far this season have exceeded the average analyst estimate by 14 percent, with Citigroup in New York and Charlotte, North Carolina-based Bank of America beating them the most.
The industry trades for 0.9 times book value, or assets minus liabilities. That’s near the 0.8 level from Oct. 3, which was the lowest since April 2009. More than $2 trillion of global losses and writedowns related to subprime mortgages sent financial companies in the S&P 500 down 57 percent in 2008.
Implied volatility, the key gauge of options prices, for the financial ETF’s at-the-money options expiring in three months fell 30 percent since its Oct. 4 high to 39.18 yesterday.
The VIX, as the Chicago Board Options Exchange Volatility Index is known, declined 31 percent from its Oct. 3 peak to 31.56 yesterday. The volatility gauge remains above its 21-year average of 20.49. Europe’s VStoxx Index, which measures the cost of Euro Stoxx 50 Index contracts, fell 18 percent to 39.67. The VIX rose 9.1 percent to 34.44 today, while the VStoxx gained 0.6 percent to 39.89.
Among all financial companies in the S&P 500, Morgan Stanley had the biggest decline in implied volatility, dropping 45 percent from Oct. 4 to 64.01 yesterday. The New York-based company, which fell to its lowest level since December 2008 on Oct. 3, has rebounded 33 percent since.
Citigroup three-month options 10 percent below the current stock price cost 18 percent more than calls 10 percent above it. The change in the price relationship dropped from its 44 percent high on Oct. 3 for the biggest decline among all S&P 500 financial companies. It reached an 83 percent premium in April 2007, a record, Bloomberg data show. Shares of the New York- based company rallied 29 percent from a 30-month low on Oct. 3.
“What we’ve seen with this rally is the fear being taken out of the market,” Justin Wiggs, who trades financial stocks at Stifel Nicolaus & Co. in Baltimore, said in a telephone interview. Earnings “weren’t as bad as some people had feared,” he said.
Talks in Paris
Officials from the Group of 20 nations concluded weekend talks in Paris by endorsing parts of Europe’s emerging plan to avoid a Greek default, bolster banks and curb contagion, setting an Oct. 23 deadline. Steffen Seibert, German Chancellor Angela Merkel’s spokesman, said “dreams” of an imminent resolution aren’t likely, and Merkel and French President Nicolas Sarkozy pledged to deliver a plan by Nov. 3.
Banks aren’t luring Malcolm Polley, who oversees $1.1 billion as chief investment officer at Stewart Capital in Indiana, Pennsylvania. The Federal Reserve’s decision to leave rates near zero until at least mid-2013 to combat stalling economic growth means banks can’t make as much from lending, he said. The firm’s sole bank holdings are San Francisco-based Wells Fargo & Co. (WFC) and Warren, Pennsylvania-based Northwest Bancshares Inc. (NWBI)
“I’m a value investor, and the downside to that is you buy things cheap, but sometimes things are cheap for a reason,” Polley said in a telephone interview yesterday. The financial industry is “a lousy business to be in right now,” he said. “Earnings are going to be under pressure for a long time.”
S&P 500 Earnings
Analysts estimate that S&P 500 earnings in the third quarter totaled $25.05 a share, up from a forecast of $24.60 on Sept. 30, according to data compiled by Bloomberg. The price- earnings ratio for the entire financial industry in the S&P 500 fell to 9.6 on Oct. 3, the lowest in Bloomberg data going back to 1993.
“Financials haven’t done well recently, and valuations are coming to a good level -- they’re becoming more attractive,” Giri Cherukuri, head trader for Oakbrook Investments, which manages $2.7 billion in Lisle, Illinois, said in a telephone interview yesterday. “Earnings reports are coming out now, so we’re getting some clarity about the financial position of all these companies.”
Seven of the 10 contracts on the financial ETF with the biggest increase in open interest over the past two weeks were bullish. January $15 calls rose by 104,191 to 213,259, while October $13 calls gained 94,408 to 374,521.
“People were protecting against cataclysmic losses,” Alec Levine, an equity derivatives strategist Newedge Group SA in New York, said in a telephone interview yesterday. “The worst-case scenario was more than priced in -- now that we’re past the earnings events people are taking their protection off.”