How to Profit From Turmoil in Regional Bank Stocks

The financial panics of the recent past have shown yet again how little people understand about the current economic situation and what is happening around them in the markets.

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Thousands of articles, reports from sell-side analysts, and investment strategy notes have been released within the last few weeks as a result of the recent failure of two regional banks that play out with the illusion that the issues we now face are simple and predictable.

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Despite the words, there are troubling numbers regarding the stock and bond markets. The conditions in the stock and bond markets have been extremely volatile because very few people, if any, forecast this latest financial crisis.

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There is a tendency to generate an overconfident analysis of opaque and difficult issues, and this generates a lot of noise. The noise itself is a reminder to investors that they need to concentrate on controllable strategies and ignore what they cannot control.

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Investing risk can be managed by buying stocks that are well run, pay dividends, manufacture innovative products with competitive moats, or are producing successful products that have a competitive advantage. Do not succumb to stereotypical statements of hubris or solemnity. Instead, savor volatility and try to profit from it.

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You can find help in the options market if you know where to look.

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As an example, let's take a look at SPDR S&P Regional Banking KRE -5.69% exchange-traded fund (ticker: KRE). Despite its bland name, the sector has unloaded a tsunami of troubles on the stock market, both here and abroad, and there are fears that it may cause more turbulence.

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Small banks, which many people thought were less risky than their Rotary Club veneers when the 2008-09 financial crisis erupted, have proven to be riskier than the systemically important banks. As a result, regulators have focused their attention on monitoring and improving small banks.

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It is estimated that the Regional Banking ETF has fallen from $64 in mid-February to around $43. Spite of the fact that Treasury Secretary Janet Yellen has told the U.S. Treasury that she will not be considering raising the federal deposit insurance limit of $250,000. It is hard to believe that the U.S. government will let the sector collapse, and destroy the confidence and savings of so many Americans.

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During this month’s torrid events, I am reminded of the collapse of Lehman Brothers. It was anticipated that many of the world’s most successful companies, both financial and non-financial, would follow suit. The government, however, was unable to let that happen. Consequently, countermeasures were taken that contributed to the present crisis, but we are not concerned with that at the moment.

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Regulators and policymakers are probably going to try to come up with a broad set of remedies after an intensive review of each of the regional banks by their regulators and policymakers have been conducted.

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If investors are interested in monetizing the entire Regional Banking sector, instead of attempting to guess which banks will outperform, they can do so by selling a cash-secured put option on the ETF. By leveraging elevated fears regarding the sector's future, investors can take advantage of the ETF's low price, which will allow them to profit from this fear.

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Considering that the ETF price is $43.35, we can assume that the May is $40 but can be purchased for around $1.80. If the put price is higher than the strike price at expiration, investors will keep the premium if it is above the strike price. If it is lower than the strike price, investors will own it for about $38.20.

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This ETF has been trading between $41.92 and $72.77 over the last 52 weeks with a range of $41.92 to $72.77.

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There is one caveat, however, to be considered when making such an aggressive position, and that is the fact that if the shares are bought, the position should be held for at least three to five years, and ideally for even longer.

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As the market mob is almost always too fearful and confident about the future, and the options market feeds off that fear and confidence to keep things moving, there is still time to rectify the problems that led to Silicon Valley Bank and Signature Bank failing.