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Investors Business Daily
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GAVIN McMASTER

Bank Stocks Kick Off Earnings This Week. How Options Help Guide Expectations.

Now that the new year is underway, it's time to get ready for earnings season. Bank stocks will be kicking off this earnings season with reports starting on Friday. That day will see earnings reports from Citigroup, Bank of America, Wells Fargo and JPMorgan Chase.

Calculating Expected Moves For Earnings Season

It's shaping up to be a busy week and bank stocks could give traders an early indicator of how this earnings season will measure up. Those that are wondering what sort of stock moves we might see can use the options market to gain an insight into the market expectation.

We can use what is called the expected move. This tells us the market's expected range for an underlying stock for a specific period.

The quickest way to work out the expected move is to look up the option chain and add together the price of the at-the-money put option and the at-the-money call option. We use the first expiry date after the earnings date.

While this approach isn't as accurate as a detailed calculation, it does serve as a reasonably accurate estimate. If you want to translate the move into percentage terms, simply take the calculation and divide it by the stock price. Also remember, the expected move doesn't tell you direction either up or down.

Expected Moves For Bank Stocks This Week

Here are some of the expected moves for some of the big bank stocks reporting this week.

Citigroup stock options are pricing in a 5.0% move in either direction. C stock stayed within its expected range three out of the last six earnings reports.

Bank of America stock options are implying a 3.6% move. BAC stock stayed within its expected range four out of the last six times.

JPMorgan stock options indicate an expected move of around 3.0%. JPM stock stayed within its expected range five out of the last six times. Five of the six post-earnings moves prior to that were out of its expected range.

Option traders in Wells Fargo stock expect the range to be around 3.7%. WFC stock stayed within its expected range five out of the last six times.

This information isn't just useful for option traders. If you have a position in bank stocks already, this information can help you make an informed decision of holding through earnings or buying ahead of earnings.

Building An Options Strategy For JPM Stock

One popular strategy with option traders is to sell an out-of-the-money put before the earnings announcement. Implied volatility is sky high due to the uncertainty around earnings so the selling premium is more attractive. Picking one of the banks stocks, here's how it works:

A Jan. 12 put option on JPM stock with a strike price of 170 is showing an implied volatility of 36% compared to 19% for JPM stock.

Traders selling that 170 put would receive $165 in option premium. If JPM stock finishes at 170 or above, the put expires worthless and the trader gets to keep the whole premium. It's not much premium, but for just a few days that represents an 89% annualized return. Not bad among bank stocks.

Understanding Risk

If JPM stock drops below 170 on Friday, the put seller would be required to take ownership of 100 shares of JPM stock at 170. With the premium received, that gets you into the stock at roughly a 1% discount from its current trading price. That means your risk is actually slightly less than buying the stock outright.

Since bank stocks and financial stocks in general are showing improving relative strength, picking up shares at a discount is not necessarily a bad thing.

According to the IBD Stock Checkup, JPM stock is ranked No. 1 in its money center group of bank stocks. It has a Composite Rating of 99, an EPS Rating of 95 and a Relative Strength Rating of 86.

Good luck this week traders.

Please remember that options are risky, and investors can lose 100% of their investment.

This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ

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