I believe the financial markets will continue to mirror the major markets overall and analysts believe that the larger markets will remain in a trading zone for the foreseeable future. This gives us an opportunity at certain points to design and implement a short term income strategy for stocks. In this case it will be Wells Fargo.
Wells Fargo (WFC) is by far the largest loan originator in the United States. Mortgages constitute almost a quarter of the company's revenue. Even though it is the largest, it did give up a very small portion of the market to rivals. Presently it has almost a third of the entire market with its major competitors being JP Morgan (JPM) and U.S. Bank Corp. (USB). Even though these two saw a share of the market grow, Wells Fargo still has nearly three times the market share of its closest competitor, JPMorgan.
Risk in Portfolio
Wells Fargo has the largest home mortgage portfolio in the nation but also is the largest U.S. commercial bank with the highest percentage of hard-to-value assets. These level 3 assets consist of 14.5 percent of its holdings the San Francisco-based firm had tagged for sale as of March 31, S&P said yesterday in a report. S&P analyst including Stuart Plesser has this to say about these types of assets:
Level 3 asset values use inputs that are unobservable and are often based on internal modeling. Because they are the most subjective, and least liquid, of the three types of assets, we believe they carry the most risk relative to others in the portfolio.
Compare this risk ratio with JP Morgan at 6.8 percent.
Foreclosures are back on the Rise
Foreclosures have started to increase this second quarter of the year for the first time since 2009. Why the sudden increase? One reason may be the backlog of defaults that are now being processed that had been on hold since 2010. Besides the millions already going through the process 311,000 new ones have begun.
Even though the markets have greatly increased as of late, the overall sentiment is not bullish and the financial markets are still struggling. With this new increase in mortgage defaults there is a high probability that it may have an adverse affect upon the bank.
The Options Play
Presently trading at 34.26, and since I believe the stock will remain trading in a zone between (30.00- 34.25) it will reverse direction soon. For this reason I will look at a bear put spread strategy.
- Buy an October 2012 put with a strike of '34' (priced at $1.59)
- Sell an October 2012 put with a strike of '33' (priced at $1.16)
- Net Debit to Start: $0.43
- Maximum Profit: $0.57
- Maximum Risk: net debit
- Maximum Length of Play: 3 months
Reasoning behind the Trade
- Markets as a whole are predicting to be within a trade zone. Therefore so will financial markets.
- At the top of the Bollinger bands and I expect it to go down soon.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.