Financials Surge Again: 10 Ways to Profit and Protect

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 |  Includes: AXP, BAC, BK, C, DIA, FAS, FAZ, GS, JPM, MS, QQQ, SKF, SPY, STI, STT, TLT, UYG, WFC, XLF
by: Option Maestro

With the stock market rallying again on Wednesday, it would have been another great opportunity to get protective, as it's cheaper on up days.

I believe this may just be a short squeeze riding into the options expiration Friday, as I think that the market is still due for a correction (see why from the chart here).

I believe that financials, being the sector with the largest gains, as seen from the table below, may suffer the largest pull back if the market happens to correct.

Company March 6 Low July 15 Close % Change
American Express 9.71 27.22 180.33
Bank of America 3.00 13.42 347.33
Bank of NY Mellon 15.67 29.37 87.43
Citigroup 1.00 3.17 217.00
Goldman Sachs 73.25 155.26 111.96
JP Morgan 14.96 36.26 142.38
Morgan Stanley 16.70 28.80 72.46
State Street 17.34 47.53 174.11
SunTrust 8.76 16.77

91.44

Wells Fargo 7.80 25.30 224.36
Average % Change 164.88
S&P 500 666.79 932.58 39.86
Click to enlarge

As you can see, financials have gained over four times the S&P average since market bottom.

In this post I will write about 10 Buy/Write option scenarios which, if purchased and the stock stays above the indicated strike price, you'll return the given % (in just 37 days).

If the stock drops more than the downside protection indicated, you "bank" 100% profit on your covered call option, but will hold the stock at a net loss.

The good news is you'll be able to write it out for another expiration ("roll" it forward).

The Buy/Write option strategy is buying the stock and immediately writing a covered call on it, therefore this post requires the knowledge of options. Covered call options are an excellent way to create a source of income for your portfolio, as I'll show you 10 ways with 10 financial stocks below. You may have heard options are extremely risky, but this type of option strategy is actually safer than holding the stock if the market corrects, the trade off however is that if the market continues to rally you have limited upside. Click here to learn more about getting into and out of option strategies like the ones mentioned above, option pricing, and more.

For this analysis I've decided to choose a strike price with a premium, which will yield at least 8% downside protection, and return at least 2% (if the stock stays above the indicated strike over the next 37 days).

All data is as of market close Wednesday July 15, 2009.

Buy Write Option Strategy #1: Buy American Express (NYSE:AXP) stock and sell the August 25 Call option. This will give you downside protection of 12.12%. The current options market is factoring in a 69.9% probability American Express will close at or above the indicated strike at August options expiration yielding a 3.97% return.

Buy Write Option Strategy #2: Buy Bank of America (NYSE:BAC) stock and sell the August 12 Call option. This will give you downside protection of 14.98%. The current options market is factoring in a 72.8% probability Bank of America will close at or above the indicated strike at August options expiration yielding a 4.40% return.

Buy Write Option Strategy #3: Buy Bank of NY Mellon (NYSE:BK) stock and sell the August 27 Call option. This will give you downside protection of 11.07%. The current options market is factoring in a 69.3% probability Bank of NY Mellon will close at or above the indicated strike at August options expiration yielding a 3.00% return.

Buy Write Option Strategy #4: Buy Citigroup (NYSE:C) stock and sell the August 3 Call option. This will give you downside protection of 8.20%. The current options market is factoring in a 84.2% probability Citigroup will close at or above the indicated strike at August options expiration yielding a 2.84% return.

Buy Write Option Strategy #5: Buy Goldman Sachs (NYSE:GS) stock and sell the August 145 Call option. This will give you downside protection of 8.87%. The current options market is factoring in a 71.0% probability Goldman Sachs will close at or above the indicated strike at August options expiration yielding a 2.26% return.

Buy Write Option Strategy #6: Buy JP Morgan (NYSE:JPM) stock and sell the August 34 Call option. This will give you downside protection of 9.51%. The current options market is factoring in a 70.0% probability JP Morgan will close at or above the indicated strike at August options expiration yielding a 3.28% return.

Buy Write Option Strategy #7: Buy Morgan Stanley (NYSE:MS) stock and sell the August 27 Call option. This will give you downside protection of 10.52%. The current options market is factoring in a 68.3% probability Morgan Stanley will close at or above the indicated strike at August options expiration yielding a 4.27% return.

Buy Write Option Strategy #8: Buy State Street (NYSE:STT) stock and sell the August 45 Call option. This will give you downside protection of 10.10%. The current options market is factoring in a 65.70% probability State Street will close at or above the indicated strike at August options expiration yielding a 4.78% return.

Buy Write Option Strategy #9: Buy SunTrust Financial (NYSE:STI) stock and sell the August 15 Call option. This will give you downside protection of 14.91%. The current options market is factoring in a 72% probability SunTrust will close at or above the indicated strike at August options expiration yielding a 4.35% return.

Buy Write Option Strategy #10: Buy Wells Fargo (NYSE:WFC) stock and sell the August 24 Call option. This will give you downside protection of 10.00%. The current options market is factoring in a 61.6% probability Wells Fargo will close at or above the indicated strike at August options expiration yielding a 4.86% return.

These options expire on August 22; therefore the last trading day is Friday, August 21, 2009.

As you can see the less volatile the underlying stock and greater probability of expiring above indicated strike price at expiration, the lower the return percentage usually is by expiration. In the case the option expires out of the money (dead), meaning it drops and closes below the indicated strike price at expiration, I just write it out for a similar strike for the following month.

If you are more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly. If you’re more bearish, write deeper in the money calls; you will not return as much if you get called out, but if you do, and the overall market is down you’ll most likely outperform the market.

Based on the analysis performed above the "Best Bang for Your Buck", would be either American Express (AXP), Bank of America (BAC) or SunTrust Financial (STI). This is because all three of these stocks have higher than average (from the 10 stocks analyzed) downside protection, and return %. The two stocks of the ten which rank above average in all three categories are Bank of America and SunTrust. Out of these two stocks which rank above average in all three categories, Bank of America is higher than SunTrust in all three categories, making that the stock which is the "best bang for your buck".

This will certainly play a role in picking my income generating stocks for the August expiration, as I may be opening some contracts soon for Bank of America (BAC) and this expiration.

For your convenience I have created a printable spreadsheet which clearly shows which stocks are above average by highlighting the % in a color here.

Disclosure: Long AXP, BAC, GS 100 Leap 2011 Call Options