Yahoo Finance Join the Morgan Stanley (MS) Stock Party — Go Long!
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Banks finished the quarter strong on the back of the stress test results. They collectively spiked about 5% on the news of impressive buybacks and dividend increases. Not many of us were too worried that they would pass yet the rally still ensued.
Source: Adrian Scottow via Flickr (Modified)
Morgan Stanley (NYSE:MS) stock, like most banks, is at multiyear highs, but that’s not to say that they are bloated. Although last week’s buyback announcements qualify as financial engineering, at a 13 price-to-earnings ratio, MS is hardly precarious. These are the leading financial institutions on the planet and their stocks have underperformed due to the lasting effects of the 2008 debacle.
The shackles haven’t only been on Morgan Stanley. The byproduct of the financial crisis is the inception of excessive regulatory caution by way of tighter rules and regulations. President Donald Trump vowed to eliminate much of the red tape, so that these institutions can lend again.
Add to this that the U.S. Federal Reserve is in a tightening cycle, rates are likely to climb. Perception on Wall Street is that bank P&L’s would improve with higher rates. So stocks like MS rallied as much as 40% since the 2016 U.S. elections.
And as long as the equity markets don’t correct, banks should are not likely to give the much of the rally back.
The promises of equity returns that the banks announced last week are likely to make their stocks unattractive short ideas. It’s a matter of math, since they told us that they will prop up their own stock prices.
Those looking for short opportunities would want to pick on wounded gazelles, not ones like the financial sector. Even Wells Fargo & Co (NYSE:WFC) which had a very-high-profile flub still is 23% higher than last November.
Technically, Morgan Stanley stock near nine-year highs yet still isn’t expensive. With a P/E of 13 and a price-to-book just over 1, it’s hardly a big mistake to own the shares here. Still, today I will profit from the stock momentum by generating income with no money out of pocket. I will not chase the rally. Instead I will bet that recent support levels will hold through 2017.
The underlying assumption that is important to me is that I am willing and able to own the shares if price dips a little in the next few months.
MS Stock Trade Idea
The Trade: Sell MS Jan 2018 $37 puts and collect $1 to open. This is a bullish trade that would profit even if price stalls. I have an 85% theoretical chance that price would stay above my strike so that I retain my maximum gains. Otherwise I will own the shares and could suffer losses below $136.
Selling naked puts is not suited for all investors so for a milder version of this trade I can use spreads instead. There the risk is limited, thereby reducing the margin required to open the trade.
The Safer Bet: Sell MS Jan 2018 $37/$35 credit put spread where I have about the same chance of success but with limited risk. Yet if successful, the spread still delivers 20% in yield. Compare this with needing to risk $44.50 now and without buffer then hop that the stock rallies 20% just to match the performance of the spread.
Investing always carries risk otherwise it won’t have any potential for reward. So I never risk more than what I am able to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
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