Private: Brokerage Volatility Trade

Top Brokerage Stock Could Benefit 8.5% From Volatility (We Could Gain 33%)
BY: Jared A Levy

As traders shuffle positions to protect and profitfrom increasing market gyrations, one of top online brokerage firms in the United States stands toprofit


We made a 53.1% profit on a similar trade just a few weeks ago when we bought calls on CME Group (NYSE: CME) to trade the jump in market volatility. Now, we have a similarly undervalued pick in E*TRADE that should benefit from the increase in trading volume regardless of the direction the market moves.

But before I dive into the details of today’s trade, let me give you a little background on E*TRADE. The brokerage firm has come a long way since its “talking baby” days.

I’m sure everyone remembers these commercials… Thanks to this talking baby featured in the Super Bowl commercials, E*TRADE’s popularity took off. Source: E*TRADE | YouTube

The company, which executed the world’s first online trade by an individual investor more than 30 years ago, has evolved into a diverse financial firm — offering investments, banking services, loans and mortgages.

Since surviving a near-bankruptcy experience in 2008, E*TRADE has emerged stronger than ever, posting record revenue and earnings growth with new product offerings, trading technology, acquisitions and trading.

Lately, the company has been heavily focused on providing services to options traders, as commissions tend to be a little higher and traders can participate and profit from a myriad of scenarios (as opposed to stock traders, who can only buy or short). In other words, the options market provides more trades… which means more income for ETFC.

Personally, I believe E*TRADE’s 2016 acquisition of OptionsHouse (my former employer) was a major turning point for the company. Just two years before E*TRADE’s acquisition, OptionsHouse had actually completed its own acquisition of options broker tradeMONSTER, and was boasting a powerful and intuitive platform and trade execution that ETFC has now adopted.

OptionsHouse and tradeMONSTER also spent heavily on education to help ensure their customers knew what they were doing. Customers that make money overall will keep on trading, which, again, means more money collected from trading fees.

And with overall options volume at all-time highs — up 41.8% from 2017 — ETFC has a large pool to capitalize on.

That’s a great foundation for today’s trade… but there are two key current events that will help us unlock our gains.

The first key event is also the most important: Volatility has returned — and is likely here to stay. (At least for a while.)

The “Goldilocks” market conditions we’ve been enjoying are gone… and that means traders must be diligent to protect their investments. Just like I said in my CME writeup, I believe E*TRADE’s profits from “protective trades” are likely to grow exponentially over the next year as savvy investors start using futures and options to protect their holdings.

The increase in volatility also means that option premiums are higher, which should re-ignite an entire nation of traders who focus on writing puts and covered calls — two very popular trades that lost their spark as the VIX (and option premiums) was at all-time lows.

But besides the amount of trading business and volume that E*TRADE is now exposed to, the overall climate for banking and brokerage is getting stronger.

That’s partly thanks to the second key event — the Senate’s recent rollback of parts of the Dodd-Frank Act of 2010. This highly restrictive piece of legislation was enacted to protect banks from becoming too big to fail and guard consumers from another financial crisis. While portions of the act were helpful, it stifled the growth of many banks and brokerages.

These rollbacks will only help E*TRADE grow stronger.

Rising interest rates are also going to benefit the company, as it will be able to charge more for every type of loan offered, including margin accounts.

Here’s the bottom line: ETFC is well positioned in a high-growth sector. And on top of everything else, its fundamental valuations are bullish, to boot.

Just look at the PEG ratio, a metric that acknowledges that growth companies often carry higher price-to-earnings (P/E) ratios than more mature blue-chip companies. Based on a forward P/E ratio of 17.4 and analysts’ estimates that ETFC company will grow earnings at an average annual rate of 21.7% for the next five years, the stock boasts a PEG ratio of 0.8… which makes the company downright cheap. (Remember, a PEG below 1 is considered “value priced.”)

Analysts having also been stepping up their ratings: The vast majority of analysts following the stock rate ETFC as a “buy,” with no “sell” ratings. The consensus target for shares is $63.33, and my models are showing a high likelihood of an earnings beat when ETFC reports around April 19.

I’m setting an initial target of $62.60 for shares — about 8.5% above current prices near $57.70 — that I believe we can attain before the earnings report, but I may modify our target ahead of the report if it has not been met.

A less-than-10% move would be enough for us to potentially grab 33.3% from this growing brokerage firm by summer.

This Week’s Trade: Make 33.3% From An 8.5% Move

Currently, ETFC is trading around $57.70. This week, I recommend buying (to open) ETFC Jul 55 Calls for $5.70 or less. That’s an ETFC call option with a strike price of $55 that expires on July 20, 2018. This call option has a delta of 0.64, which means it will move roughly $0.64 for every dollar that ETFC moves.

As this issue is going out, the option is trading with a bid of $5.70 and an ask of $5.95. This is slightly higher than my “buy under” price, but we don’t want to chase this stock. Shares moved up this morning, but I believe the calls will fall back below my recommended price and that we should be able to get in. Be sure to set your entry orders now so that you don’t miss the move.

[If you need a refresher on how calls work or how to execute a trade, check out our options buying guide here.]

Each contract you buy will cost about $570 (assuming you enter the trade at the “buy under” price). Because each contract controls 100 shares of the underlying security, we multiply the $5.70 option price times 100. This is still much cheaper than buying 100 shares of ETFC, which would cost $5,770.

This trade breaks even if shares rise to $60.70 (strike price of $55 + premium of $5.70), about 5.2% above current prices.

Targets: The goal here is for ETFC to rally to $62.60 by expiration on July 20.

If the stock reaches $62.60, the call option will have at least $7.60 of intrinsic value (target price of $62.60 – strike price of $55), no matter how much time is left until expiration.

Once you’ve bought the call option, immediately place a GTC limit order to sell that option for $7.60. If the option hits our price target, we’ll generate a 33.3% gain in 127 days, or 95.8% annualized.

Stops: For the option, set a hard stop at $2 to preserve capital if the trade moves against us. If our option reaches that level, it will be sold from the portfolio. Be sure to account for that risk when deciding how many contracts to purchase.


Buy (to Open) ETFC Jul 55 Calls for $5.70
Cost of Trade (Per Contract): $5.70 ($570)
Target Stock Price: $62.60
Target Option Price (Per Contract): $7.60 ($760)
Target Profit: 33.3%
Hard Stop Price (Per Contract): $2 ($200)
Max Risk Per Contract: $500 ($570 cost – $200 stop)
Stock Breakeven: $60.70
Delta: 0.64
Expiration Date: July 20, 2018
Anticipated Days in Trade: Less Than 127 Days

Recommended Trade: Buy to open ETFC Jul 55 Calls for $5.70 or less.

Note: I recommend limit orders to execute trades. If prices move and you can’t get in at the recommended price, don’t chase the trade. This is a weekly trading service, so you’ll have plenty of opportunities for big gains using options. Don’t sacrifice profits on account of excitement.