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Don’t Bank on it

18 July 2022

Don’t Bank on It

Wells Fargo (WFC) posted earnings on Friday morning that were underwhelming. Profits declined 48% from a year earlier, while revenue and earnings both fell short of expectations. Yet the stock soared 8% before closing 6.2% higher. Why the jump on seemingly bad news? It’s anyone’s guess, though it’s typical to parse the data to spin a bullish story. For WFC, it was strong net interest income. Whatever.

Oddly, there was no analyst activity following the report. No upgrades or downgrades. No target price changes. WFC remains a solid buy among the 30 or so covering analysts, while the target price average is $53.36, 30% above Friday’s close. I guess analysts don’t like to criticize their peers.

Analysts haven’t been getting a whole lot right with WFC this year. Despite the glowing predictions, the stock is down more than 30% from a February high. And Friday’s rally was soundly rejected by the 50-day moving average, which marked tops in March and June. In fact, the trendline hasn’t allowed a daily close above it since late February.

Parse the data all you want. WFC came up short on the big numbers. Consider this a “fade the rally” trade that is banking on WFC’s downtrend continuing. We are using a call credit spread with the short call strike (red line) sitting above the 50-day moving average (blue line).

If you agree that the 50-day moving average will continue guiding WFC lower, consider the following trade that relies on the stock staying below $43 through expiration in six weeks:

Buy to Open the WFC 26Aug 46 call (WFC220826C46)
Sell to Open the WFC 26Aug 43 call (WFC220826C43) for a credit of $0.70 (selling a vertical)

This credit is $0.02 less than the mid-point price of the spread at Friday’s $41.13 close. Unless WFC drops quickly, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $68.70. This trade reduces your buying power by $300, making your net investment $231.30 per spread ($300 – $68.70). If WFC closes below $43 on August 26, both options will expire worthless and your return on the spread would be 30% ($68.70/$231.30). 

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