Betting on Banks Before the Stress Test Results?

Close QID, Plan to Sell TBT

By Bryan Bottarelli
Thursday, April 09, 2009 9:50 AM EDT
Thu, 9 Apr 2009 13:50:00 GMT

Dear Bottarelli Research Member,

With the markets closed for Good Friday tomorrow, this will be our last day of alerts for the week. Overall, we’ve been on a nice run lately, hitting consecutive winners of 42%, 37%, 41%, and 34% on DNDN, AEM, ESI, and POT, respectively. But this morning, a surprise record-breaking profit report from Wells Fargo has propelled the major market averages higher, forcing us to close out our QID April 45 Calls (QID DS). If you haven’t already done so, close this play now.

I don’t know about you, but I find this WFC profit report to be very suspect. After all, I was reading an article from Reuters last night that quoted an anonymous source who is familiar with the government-induced “stress test” on the banks. According to this source, the U.S. Treasury Department is planning to delay the release of the completed bank stress test results until after the first-quarter earnings season. The reason for this delay is that they don’t want to disturb the markets. Hmmm.

In other words, they want to let a company like WFC report blowout earnings — which shoots the markets higher. And then, after all of these blowout earnings reports from the banks have been reported, then they’ll come out and report (what looks to be) troubling conclusions from the stress test.

As you know, the purpose of this stress test process is to assess how the 19 largest U.S. banks would fare under more adverse economic conditions. These tests are expected to be completed by the end of April, but the Treasury has recently reported that they’ll be done before the end of the month. As I look at this situation, combined with WFC’s news this morning, something just doesn’t smell right. The fact that the Treasury is all of a sudden so concerned about how to release these results indicates to me that they’re not good. After all, if all the banks had passed the stress test, they’d simply report the results and let the financial sector soar. But according to the insider source, the Treasury is now concerned about avoiding further stock market complications.

From a trading aspect, this could be setting up for a powerful upside call play on the UltraShort Financials ProShares (SKF – NYSE), which is down another $11.00 in early action (and is not indicated on the chart below):

SKF

The SKF moves at a rate of twice the inverse of the financial sector, and as you can see from the chart, the recent financial rally has pushed it aggressively lower. If the stress test results reignite a new round of market fear, then any sell-off in the financial sector could lead to an explosive call play opportunity on the SKF. As always, I’ll keep you fully posted.

In terms of our one remaining trading position, the market upside is helping out our TBT June 44 Calls (TBT FR). As you know, we entered these puts on April 3rd for $3.32, and they’ve moved up to $3.90 in today’s early trading. If they hit $4.00 today, let’s go ahead and lock in our profits. That way, we’ll go into the long market weekend with a cleared-out trading ledger.

PLAY: Sell your TBT June 44 Calls (TBT FR) at or above $4.00, good for the day.

As always, I’ll be out later in the session with more updates. But until then…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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