A bank ETF could bounce if inflation data is cooler than expected, Bank of America says
The rapid shift in expectations away from multiple rate cuts this year may have created a trading opportunity around Wednesday’s inflation data, according to Bank of America. Equity and quantitative strategist Ohsung Kwon said in a Monday note to clients that markets appear to be pricing in bad news for inflation and, by extension, higher-for-longer interest rates. That means a softer-than-expected reading for the consumer price index could lead to a quick bounce for some beaten-down parts of the stock market. “CPI above consensus for five straight months and rates market priced out five cuts [year-to-date]. We believe squeeze risks for rate-sensitive laggards on a CPI miss outweigh downside risks on a CPI beat,” Kwon wrote. The “squeeze risk” can refer to a situation in which short sellers are forced to rapidly cover their positions when information around a stock or sector changes. This creates additional buying pressure and potentially a big jump in price that may seem larger than justified by fundamentals. Specifically, there could be an opportunity to bet on the squeeze risk through the SPDR S & P Regional Banking ETF (KRE) , Kwon said. The fund has comparably priced options as are available in the iShares Russell 2000 ETF (IWM) , which is typically less volatile than the bank-focused fund. “Friday-expiry KRE straddles cost just 20% more than IWM straddles, despite reacting 45% more to CPI and exhibiting 40% higher beta to CPI surprises over the last 12m. Also, 101% short interest in KRE is by far the highest across rate-sensitive ETFs … and our banks analysts also see potential for a catch-up rally in regionals,” Kwon said. Straddles are a type of option that let investors bet on volatility in either direction. Regional banks have been pressured by higher interest rates, which have devalued some of the loans and bonds on their books. If lower inflation readings led to quicker rate cuts from the Federal Reserve, that would help the sector avoid more failures, such as what occurred with Silicon Valley Bank and First Republic in 2023. The price of the KRE is down about 4% year to date, compared with a gain of more than 9% for the S & P 500. KRE YTD mountain This regional bank ETF is underperforming the broader market year to date. Investors could position for this potential squeeze by buying the ETF outright, though that does carry the risk of a hot inflation reading pushing regional bank stocks down. But Bank of America also highlighted an options play to take advantage of a squeeze. “To position for this short-term squeeze, buy KRE 17May 51-53 call spreads for $0.35 (5.7x max payout),” Kwon said. A call spread is an options strategy that involves buying one call option and then selling another one with a higher strike price to help offset the cost. A call option gives the holder the right to buy the stock or ETF at a given strike price. The idea of a call spread is that if the price of the ETF rises above the lower strike price by enough to offset the cost of the options, the trade will make money. This strategy limits the potential upside if the trade goes well, but the losses if the fund moves in the opposite direction are capped at just the upfront cost of the options. — CNBC’s Michael Bloom contributed reporting.
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