Wells Fargo (WFC) is currently trading at a level near $34 again. It had been at this level twice before, in 2010 and in 2011, but had never broke the resistance at $34.
I am betting that it will not break the resistance again this time and is a sell at current levels. Here is why.
When the bank got funding from the government under the Troubled Asset Relief Plan (TARP), the government received warrants. These are call options to buy Wells Fargo shares at a price of $34.01. These warrants are long-dated options, and it is a long time before this option expires -- not until Oct. 28, 2018. This is more than six years away. Indeed, I believe that these TARP warrants are very attractive securities in the long term, but that's a subject for another post.
Currently, very savvy investors and hedge funds hold these TARP warrants, and I believe they have been doing so for some time. Given that they bought these out-of-the-money warrants at a relatively high price (due to the long time value), I am sure these investors would be currently selling calls against their holdings of these long-dated TARP warrants, trying to make some money while waiting for 2018.
It is essentially not a very risky trade for them. Holding TARP warrants at a strike of $34.01, if one sells a $34 call against the warrant, one essentially is doing a spread and the risk is minimal. Even if the price of the shares goes above $34, their loss on their short calls would be somewhat offset by their gains on their TARP warrant. It would be even more profitable if the underlying calls that they sell expire worthless, so they get the premium of these call warrants and still get to keep their TARP warrants.
Hence, I believe that while the price of Wells Fargo is near $34 (or goes even slightly above $34), hedge funds will be selling calls at this level. When they have had their fill of short calls, they will likely start to short the shares proper to bring it down so that the calls they have shorted will expire worthless.
I believe that is why you see a large open interest in the calls with strike price of $34 expiring in May 2012. Hence, come the end of May, Wells Fargo will likely be trading at less than $34.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
