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A Bank Could Be Your Next Triple Digit Gain

A Bank Could Be Your Next Triple Digit Gain

Bank stocks are often thought of as conservative investments. And they were at a time. But now financial institutions tend to be more volatile than they were in the past. That’s one reason traders should watch for news to provide a catalyst for a price move and then search for a trade.

Strong Earnings Fuel a Rally

Business Wire reported that First Republic Bank (NYSE: FRC) announced financial results for the quarter and year ended December 31, 2018.

“Results for 2018 were excellent,” said Jim Herbert, Chairman and CEO. “Organic growth continues to be strong across the franchise. Our client-focused business model is driving our growth and delivering consistent results in all types of economic conditions.”

Zacks agreed, noting that the company “registered a positive earnings surprise of 4% in fourth-quarter 2018, reflecting higher revenues. Earnings per share came in at $1.29, outpacing the Zacks Consensus Estimate of $1.24. Moreover, the figure improved 17.3% from the year-ago tally.

Top-line strength positively drove the company’s performance. In addition, a considerable rise in loans and deposit balances was recorded. However, despite rising rates, net interest margin disappointed on high deposit costs. In addition, higher provisions and expenses were undermining factors.

Net income available to common shareholders for the reported quarter jumped 19.6% year over year to $215.2 million.

For full-year 2018, net income was $853.8 million or $4.81 per share, up from $757.7 million or $4.31 per share in the prior year. Full-year earnings also outpaced the Zacks Consensus Estimate of $4.75.

For 2018, net revenues were $3 billion, up 16.6% year over year. The top line was almost in line with the Zacks Consensus Estimate of $3.02 billion.

Net revenues in the quarter came in at $810.8 million, up 16% year over year. Furthermore, the figure readily surpassed the Zacks Consensus Estimate of $790.3 million.”

Traders seemed impressed with the beats on the top line and bottom line.

Zacks concluded, “First Republic Bank reported an impressive fourth quarter. The company’s efforts to maintain its organic growth momentum, backed by improvement in loans and deposits, which boosted revenue performance, highlight optimism.

Nonetheless, higher expenses, and provisions, and decline in net interest margin remain concerns.”

The company also took steps to shore up its balance sheet. On December 28, 2018, the Bank redeemed all of the outstanding shares of its 7.00% Noncumulative Perpetual Series E Preferred Stock, which totaled $200.0 million.

On December 31, 2018, the Bank traded 2,000,000 new shares of common stock as part of an “at-the-market” equity offering program, in conjunction with the addition of our common stock in the S&P 500 Index prior to the market opening on January 2, 2019.

This offering settled on January 3, 2019 and added approximately $170 million to common equity in the first quarter of 2019.The additional shares should help the company maintain liquidity now that it is part of the S&P 500 Index and that inclusion.

FRC weekly chart

The stock could have support near recent lows and that would limit down side risks.

A Trade for Short Term Bulls

As with the ownership of any stock, buying FRC could require a significant amount of capital and exposes the investor to standard risks of owning a stock.

To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.

Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.

To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.

This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.

bull call spread

Source: The Options Industry Council

Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.

This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

A Specific Trade for FRC

For FRC, the February 15 options allow a trader to gain exposure to the stock.

A February 15 $95 call option can be bought for about $2.15 and the February 15 $100 call could be sold for about $0.70. This trade would cost $1.45 to open, or $145 since each contract covers 100 shares of stock.

The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $145.

The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.

For this trade in FRC the maximum gain is $3.55 ($100 – $95 = $5.00; $5.00 – $1.45 = $3.55). This represents $355 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $145 to open this trade.

That is a potential gain of about 144% in FRC based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.