Financial Strength

Richard Croft
January 17, 2011
4 minutes read

After being range bound for the past three months, Canadian financials have broken out to the upside. Not surprising given the rebound in US banks. US banks reacted positively to JP Morgan Chase & Co. (NYSE: JPM, recent price US $44.91) quarterly earnings report last week.

The JPM numbers blew right through consensus estimates. Posting US$1.12 earnings per share compared with an expected US$0.99 for the fourth quarter. More shoes will likely drop in the coming weeks as Bank of America (NYSE: BAC, US $15.25) and Goldman Sachs (NYSE: GS, US $175) report earnings. Nothing like an earnings surprise to put a fire under the banking sector in the US as analysts jump over each other to raise price targets.

Interestingly it took an earnings surprise in the US to lift Canadian banks. But now that Canadian banks have come into focus, one might reasonably expect them to outperform in the months ahead. Especially given that they were already in better shape than their US counterparts. And what with more international investment flowing into Canada to take advantage of our resource-rich environment and the fact that Canada is recognized internationally for its financial stability.

On the flip side, you need understand that Canadian banks have already rallied from the depths of the financial crisis. Certainly they have recovered much more than their US counterparts, which might mean that US banks are playing catch up. And when it comes to earnings, the US banks will look much better on a comparative basis, because they are coming off such low levels.

If you are a bold option trader, you might want to bet on this trend continuing. Looking specifically, at bullish trades on individual Canadian banks or on a broad Canadian financial index fund, such as the iShares S&P/TSX Capped Financials Index Fund (TSX: XFN, $23.45).

When you look at options on financial stocks, you cannot help but notice they are relatively cheap. Canadian option premiums are in line with levels in the US, where implied volatility levels are at or near 52 week lows. Simply stated, bullish option traders should look at buying calls to take advantage of any potential rally.

In order of preference, I would look at the CIBC (TSX: CM, $78.36) April 80 calls at $1.95, or Bank of Montreal (TSX: BMO, $59.53) April 60 calls at $1.55 as my primary choices. The view being that CIBC, along with Bank of Montreal, took the biggest hit during the financial meltdown, and have the most upside should we see a series of earnings surprises.

For exposure to emerging markets, I would look at Bank of Nova Scotia Bank (TSX: BNS, $56.83) April 58 calls at $1.40. If you buy into a broad based global recovery, emerging markets will have the greatest upside, which directly impacts BNS.

Next I would look at Toronto Dominion (TSX: TD, $76.17) April 78 calls at $1.35 or Royal Bank (TSX: RY, $53.89) April 54 calls at $1.65. Both of these banks have gained market share in the US, and should benefit from the US recovery.

If you prefer to play the financial sector rather than picking individual banks, take a look at the XFN options. Specifically the XFN March 24 calls at 24 cents.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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