Why Banks Have a Friend in Bernanke
Ben Bernanke could be the banks' best friend. At least, that's what options traders seem to think.
Even before Bernanke hinted that tapering would begin this year, bond yields have slowly been on the rise. When the Federal Reserve indicated at the June FOMC meeting that it would slow down its aggressive bond-buying program, bond prices plummeted because of the expected loss of demand.
Accordingly, bond yields rose, because of their inverse relationship with bond prices.
With higher yields and less money flowing into the economy, investors were fearful that this drought would spread into the stock market. This caused a "June swoon" in the market. But then June ended, and July brought with it a rebound.
After the initial news from the Fed, investors settled down and restored their confidence in the equities rally which was further boosted by Bernanke's dovish comments on Wednesday.
This led investors to conclude that quantitative easing will not end as soon investors had worried. The stock market is up 3.65 percent in a week, but bond rates keep climbing higher, and it puts bank stocks in a confusing place.
One component of a bank's revenue comes from mortgages. Generally, the bank issues a mortgage that is correlated with the interest rate of long-term Treasury bonds.
In order to hedge their lending from mortgages, banks primarily borrow from the Fed and pay out short-term interest rates. The long-term interest rates keep rising, but the Fed has indicated that it is unlikely that short-term interest rates will change in the near future.
This is great news for the banks, because it means that banks will profit off of the widening spread. The average mortgage rate is about 4.25 percent, while the bank can borrow from the Fed at the discount rate of only 0.75 percent. A wider spread for banks means greater profit per mortgage issued.
On Thursday, we are seeing heavy volume in JPMorgan. The most actively traded option is the 55-strike call expiring on Friday, which has mostly been bought Thursday, rather than sold.
With the stock backing off from the highs, it seems like a late-day rally or a rally off of Friday's earnings is eminent, as call buyers will only profit if this stock is above $55 Friday at the close of business.
I am long JPM, and seeing this trade certainly gives me confidence that holding the stock through earnings will pay off.