5 Banks to Consider as Options Plays

NEW YORK ( TheStreet) -- For a market not expected to do much before the election, it's hard to deny we are in a bull market. The S&P 500 ETF ( SPY) chart is trending higher with the widely followed moving averages all pointing north.

While many market pundits were busy building a wall of worry, others were busy making money. It's hard to say what the SPY and the overall market will do in front of the election, but even with the market giving back gains, many in the banking sector already have low growth priced in.

Banking suffers from future unknowns. Wall Street hates problems without a clear and convincing level of risk exposure. The problems with housing and high unemployment appear to have no end in sight. Nothing out of Congress or the White House suggests a change anytime soon either.

The Libor rate-fixing scandals could snapback and create exposures that may not appear on the radar for any given U.S. bank at this time. Considering the fact that the big U.S. banks are really big global banks means earnings may take hits for some time. Currently, we know Bank of America ( BAC), Citigroup ( C), and JPMorgan Chase ( JPM) possibly face exposure based on lawsuits that have been filed against them.

Because the banks have many of the problems built into the price, if the storm clouds do pass more quickly than expected (and they will pass at some point, they always do), the payoff could be huge. Banking offers the classic "heads I win, tails I break even" that investors search for. It's far from a sure thing, but when the odds are in your favor you want to exploit it for what you can.

In order to mitigate your risk exposure, take a look at writing covered calls. Writing covered calls will lower your total risk per share, pay you for each passing day as a result of time decay and increase the odds you will make money. The downside is you risk getting left behind if your stock really takes off higher.

This article isn't about hitting home runs, and more for those that want to bring home solid and consistent results. I selected November as my primary expiration month because the expiration date is after the election and gives time for the market to digest the results.

Some banks are better than others so let's take a look and see what we find.

MS Chart MS data by YCharts

Morgan Stanley ( MS)

Book Value: $31.78

Morgan Stanley has bounced back from lows in June and July, but remains well below the all-important technical 200-day moving average near $16. Morgan Stanley has more or less treaded water during the last 12 months without gaining or losing much (with more than one move higher and lower in between).

With an average analyst target price of $20.35, Morgan Stanley appears to have a lot of upside relative to the other banks. The price-to-earnings ratio reflects relative higher optimism in Morgan too. Morgan is expected to bring home about 90 cents in earnings this year making the earnings multiple slightly higher than 16.

Part of the higher premium may come from the higher dividend yield Morgan offers. This stock currently has an annualized dividend of 20 cents, yielding 1.37%. Short interest is 1.5%, indicating a near zero level of interest from short sellers.

I would prefer to sell a November expiration covered call, but October is as close as we can get. The October $15 strike calls can be sold for about 80 cents. With a current stock price of $14.90, the maximum possible return is 90 cents for a gain of 12% in less than two months. The maximum risk is $14.10 per share. Dividend payments may positively impact the results.

WFC Chart WFC data by YCharts

Wells Fargo ( WFC)

Book Value: $28.07

Over 70% of analysts rate Wells Fargo a buy or strong buy and the average price target is $38.64. If you really want a full appreciation of the differences between Wells Fargo and other banks, set your chart for monthly bars and compare the various banks. Wells Fargo and USBancorp ( USB) are the two major banks that have more or less sidestepped the financial crisis. Sure, they both became "collateral damage" during the plunge in 2009, nevertheless, they quickly recovered.

The Wells Fargo chart more closely resembles the SPY than the other stock charts listed here. Take a look and review the relative start, mid-chart pattern and relative ending prices and Wells Fargo more or less mirrors the overall market.

WFC Chart WFC data by YCharts

Wells Fargo has a bullish technical chart pattern based on the 60- and 200-day moving averages, both averages are steadily climbing a wall of worry to higher profits. Trend followers love this pattern and will hold a position until a technical break results in a signal to exit.

Wells Fargo is attractive fundamentally also. The trailing 12 month price-to-earnings ratio is 11.3, and analysts estimate $3.32 per share in earnings this year.

The company currently pays 88 cents per share in dividends for a yield of 2.58%. Wells Fargo doesn't pay the highest dividend yield in this group, but if you're willing to forego a small amount of yield for safety, Well Fargo offers a compelling argument in this space.

Short sellers are next to impossible to find. Short interest is so low I only include it to demonstrate the smart money is not betting against this company: 0.8% of the float is short based on the last reported numbers.

JPM Chart JPM data by YCharts

JPMorgan Chase ( JPM)

Book Value: $50.46

JPM pays the highest dividend of these companies profiled and has a reasonable chance of maintaining that high dividend yield. After the ordeal Jamie Dimon went through, I have to believe risk control is locked down as tight as anyone else's by now. Dimon has also reportedly called the dividend " sacrosanct ."

Analysts appear to agree because well over half of analysts rate JPM a buy. Analysts have placed a reasonable $45.14 price target on JPM. New regulations have increased the headwinds JPM faces, but it all appears priced in.

In fact, Wall Street is pricing JPM growth at zero for the next five or more years. That's OK because a 3.2% yield along with option premium spells profits for investors.

Short sellers agree that JPM is not more likely to fall than rise. Short interest is 1.1%.

BAC Chart BAC data by YCharts

Bank of America ( BAC)

"Bank" is often one of the top 10 most actively traded stocks. Traders love trying to squeeze pennies out of it every day. Some are better than others, but that doesn't change the longer term moves investors can expect. The high activity rate for Bank results in investors having the ability to enter or exit from pre-market to the closing of the aftermarket session with almost zero slippage. I believe high activity lowers the transaction costs for everyone.

Book Value: $21.90

The price-to-earnings multiple demonstrates Wall Street doesn't believe Bank will grow earnings soon, but simultaneously, investors don't need growth to profit handsomely with shares as cheap as they are. On a positive note, the average one-year price target is $9.63 and short interest is very small at 2.1%.

The 60-day moving average is bullishly above the 200-day moving average. After testing the 200-day moving average support level several times this summer, BAC appears poised to continue moving higher.

The company currently pays a paltry 4 cents per share dividend for a yield of .5%. Absent an increase in dividends, don't expect to make a lot from the yield, but we don't need to in order to make bank with Bank.

The November $8 strike calls can be bought for about 53 cents, and $9 strike calls can be sold for about 19 cents. The options are priced relatively cheap considering the moves the stock has had recently. This makes a debit spread more attractive than a covered call in my opinion.

This type of option spread has an even lower risk than a covered call, while also lowering the time decay. With a current stock price of $8, the maximum possible return is 66 cents for a gain of 90% in less than 80 days. Bank will need to increase to $8.34 to breakeven by the expiration date, and the maximum risk is 34 cents per share.

If Bank is trading above $9 per share at expiration, you lose out on everything above $9 per share, but a 90% gain will aid in your comfort. Aside from the 34 cents per share risk, the next biggest downside to this strategy is Bank does have to move higher just to break even.

C Chart C data by YCharts

Citigroup ( C)

Citi is connected to everyone and is "too big to fail." It's the "too big to fail" part that makes Citi attractive to me. I have invested in Citi several times in the past three years and believe now may be another good time to gain exposure.

Book Value: $62.72

The trailing 12 month price-to-earnings ratio says it all when it comes to pricing in growth. The trailing earnings multiple is 8 and the forward estimate multiple drops down to 7.5. Drops in earnings multiples happen when investors become skittish about the future earnings of a company.

Considering Citi (and others) likely spend as much time in court fighting lawsuits as in the office driving new business, I am not surprised the earnings multiple is as low as it is.

Citi's yield isn't much better than investing your money inside a savings account at Citi, but there are reasons why you should consider exposure despite the headwinds the bank faces.

Analysts like Citi. Over half the analysts that follow currently rate the stock a buy. Short sellers are not pushing each other out of the way to short shares at the current price.

Short interest in Citi is near 2%, and we can assume some of it is from hedging activities and not straight bearish positions. Unless a new shoe drops on Citi and or the financial sector, there is no reason why shorts will become aggressive either.

The November $32 strike calls can be sold for about $1.15. With a current stock price of $29.75, the maximum possible return is $3.40 for a gain of 11.9% in less than 80 days. The maximum risk is $28.60 per share.

I use SEC.gov, Zacks.com, WSJ.com, Tradestation, and Reuters for my data. P/E is generally adjusted P/E based on an average number of shares.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

If you liked this article you might like

Novice Trade: SPY

Novice Trade: SPY

How ETFs Can Boost Your Portfolio

How ETFs Can Boost Your Portfolio

How to Use Options to Your Advantage in This Manic Stock Market

How to Use Options to Your Advantage in This Manic Stock Market

Don't Hate the VIX Game, Hate the 'Tourist' Players

Don't Hate the VIX Game, Hate the 'Tourist' Players

Don't Hate the VIX ETPs, Hate the Tourists

Don't Hate the VIX ETPs, Hate the Tourists