Market Gives Clues to Major Fallout of Regional Banks ETF (KRE) in the Near Term

There are two major ETFs that focus on the Regional Banks, the KRE and the RKH, and two of the largest option trades in recent memory (based on contract size) took doomsday-like bets against the group today.

The first trade came at 1:48pm when a 74,900 contract purchase of the June $17.50 puts in the KRE took the offer of $0.35, a $2,621,500 bet against the ETF that requires approximately a 19% move lower for the trader to break even by the third Friday in June. The KRE fell 2.17% into the close following that massive trade, but more interesting is the amount of volume that traded in the 15 minutes, that equaled nearly 50% of the entire day’s volume pressuring the KRE to close at the lows of the day. For technicians out there, the KRE also broke below its 20 and 50 day exponential moving averages.

Later in the day at 1:55pm and 2:08pm, June $60 puts in the RKH traded 10,000 and 10,500 contract lots at $1.75 and $1.80 respectively, traders taking the offer price, a bearish indication as this implies the trader was anxious to get the order filled. The RKH was trading near $69 at the time of the trade, and would also require around an 18% move lower in the index for the trader to hit a breakeven point, eerily similar to the action in the KRE. Also, the RKH closed above its 200 day EMA once last week, but has struggled to get back above that key technical level.

Now that we see the large amounts of money betting against the Regional Banks, it would be naive to dive in without trying to answer the ever important question of, Why?

An article ran in the WSJ yesterday stating that local banks could face large losses due to exposure to commercial real estate that could amass to $200 billion of losses. It would also result in 600 of the 940 banks looked at having capital shrink to levels considered worrisome under the Stress Test.

The problem is that many of these smaller banks lack the earnings power that has investors putting money to work in the bigger banks, and these massive losses could result in multiple small bank failures. And if these smaller banks can find a way to raise capital, it will be through the selling of valuable assets and issuance of common stock, which will dilute less powerful earnings and cause a downward spiral in the stock prices of these banks.

The timeframe of the bets seen yesterday suggest that something big is about to occur in the near future that could spark trouble at many of these regional banks.

A trader can either place bets against individual regional banks that lack earnings power and sustainability, that have large amounts of bad assets on the books, or just bet against the index itself.

A more risk-adverse trader may wish to undertake a pair trading strategy, as financial stocks typically trade in a highly correlated fashion. Big banks have raised the necessary capital and the worst is likely over, so the appropriate strategy would be to pair every short of a regional bank with a long of a big bank.

A few prospective examples of this strategy:

Long Goldman Sachs (GS) and Short Associated Bancorp (ASBC)

Long Morgan Stanley (MS) and Short West America Bancorp (WABC)

Long JP Morgan (JPM) and Short City National (CYN)

Long Wells Fargo (WFC) and Short BOK Financial (BOKF)

There are many ways to use this information and different trading strategies, but in the end it appears that “smart money” is buying shares of big banks and betting against the future of the regional banks.

Disclosure: Own Puts in KRE

Comments

[Tom Armistead:]

Strage coincidence, if coincidence it was - I saw Whitney Tilson on CNBC yesterday, prophesying doom for commercial real estate and talking his book, which is short regional banks.

Well orchetrated, multiple sources provide the same information on the same day. Soon the headlines will scream about CDS spreads blowing out. Naked shorting will return.

Some select few regional banks will totter and fall. Another trillion of value will be destroyed and more billions of the fruits of destruction and manipulation will be pocketed by the perpetrators.

The SEC will discover a small Ponzi scheme among a tight knit community of Vietnamese immigrants, insder trading occuring in 2005 by means of options, and insder trading by a celebrity to be named later.

Hold your hat

May 21 05:58 AM

[Tom Armistead:]

So I reported it to the SEC - they could take someone off Celebrity Insider Trading and put them on this case before it happens.

May 21 06:08 AM

[HERMANNE:]

COMMERCIAL LOSSES WILL TANK THE REGIONALS FOR A LONG TIME TO COME
BANKS PONZI DEALS BROUGHT THIS ON
THE GREED TO GET IT ALL NOW
WILL COST MAYNY TO FAIL

May 21 06:58 AM

[SKELE:]

The below article could be good for small banks!


money.cnn.com/2009/05/...

May 21 08:53 AM

[calisdad:]

nice find but people read too much into options activity. they could close those puts today for a 1 day gain of 28%. all the incentive one needs isn't it?

May 21 09:32 AM

[Joe Kunkle:]

The puts remained open after 70% gains...

May 21 10:55 AM

[helplessobs...:]

Kunkle,
This is a great post on an important speculation with market action attached. Unlike the the seers at Delphi you have not wrapped the information in a riddle.
HObserver

May 21 04:38 PM