KeyCorp (KEY) — along with other regional banks — was a direct beneficiary of the market’s reaction to the possibility that the Federal Open Market Committee (FOMC) might start to taper its quantitative easing program. When the Fed started hinting about tapering, bond investors started selling U.S. Treasuries, which pushed their yields up higher and higher. This was a good thing for regional banks because it increased their net interest margin levels.
Banks make a good deal of their money by borrowing money at low, short-term interest rates and lending it out at higher, longer-term interest rates. As Treasury yields started to move higher, it pushed longer-term interest rates higher — widening the spread between the short-term interest rates banks were paying and the longer-term interest rates they were earning. However, when the Fed announced that it was not going to be tapering, the bloom came off the regional bank rose, and stocks like KEY began to suffer.
While the rest of the market shot higher, KEY dropped down and completed a head-and-shoulders reversal pattern. In the few days since breaking below its neckline at $11.50, KEY has come back up to retest that former support level to see if it would now hold up as resistance. Seeing the downward slide from $11.50 gives us confidence that the retest has been a success and that the stock should continue lower. We anticipate the stock is going to drop down to $10.50, but it could hit some near-term support at $11.
It is true that tighter credit markets during the current crisis could make things worse, and we are trending that way right now. It’s not as bad as it was in 2008, and the market has pulled back from the precipice several times over the last few years. We need to stay flexible in the short term so we don’t miss the kind of bullish breakout that happened after the last crisis was resolved at the beginning of the year. But right now, we clearly have a short-term bearish bias.
There are a great deal of data (despite radio-silence from government economic reports) coming out this week and early next week. Our approach will be to look for the strongest stocks in the sectors that could rally the most on a successful resolution (retail, financial, basic materials). These also happen to be the same sectors that should see the greatest losses if things degrade from here. Focusing on the fundamentals will help us concentrate on the best bearish and bullish positions in each situation.
One of the weaker names we see right now is KEY.
KEY does have an earnings announcement coming up on Oct. 16, before the market opens, so we will be keeping a close eye on price action before that time. We will most likely not still be in the trade by then, but it is important to be aware that earnings season for regional banks is coming up.
Recommendation: Buy to open KEY Nov 11 Puts for a maximum of 30 cents.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.
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