Stocks got bloodied on Tuesday, sure, but there is a silver lining to the selling. Companies that recently saw their share prices notch new highs, like Wells Fargo (NYSE:WFC), now have tempting buy-the-dip setups. Today I’ll share why bank stocks remain healthy and how to capitalize on WFC stock.
When searching for the best tickers to purchase after weakness strikes, I focus on trend and relative strength. Those that both remain in uptrends and are outperforming the broader market are the most attractive.
Of course, you can measure relative strength on any time frame, but what I’m most interested in are those that saw a momentum increase during the rally that preceded this week’s drop. As we’ll see in the chart of the Financial Sector ETF (NYSEARCA:XLF) and WFC below, both saw buyers swarm during their previous upswings.
Let’s start with the financial sector.
Financial Stocks Remain in Favor
In mid-June, the financial sector broke below its 50-day moving average alongside other cyclical sectors. It spent nearly two months stuck there until buyers finally returned to pull XLF back into an uptrend. The six-day rally was impressive and carried XLF to a new 52-week high late last week.
Though prices were dropping for the third session in a row on Tuesday, the damage hasn’t been all that bad. For starters, we’re still only 3% off the peak. For its part, the volume has been average and is suggestive of garden-variety profit-taking and not some institutionally led exodus.
With the rising 20-day moving average and 50-day moving average both looming closely below – not to mention the old resistance zone near $37 – this appears a dip worth buying. Indeed, as you look at the top dozen or so financial stocks, you’ll find many of them match the quality of the sector setup.
While bulls appeared later in the Tuesday session, it’s not yet clear if the drop is done. Regardless, I remain optimistic about buying the XLF dip as long as it remains above $37.
With that in mind, let’s take a closer look at Wells Fargo.
WFC Stock Chart and Trade
The daily chart is mirroring that of XLF, with maybe one key difference. The momentum was even stronger for WFC on its last advance. We even saw a few accumulation days to confirm big buyers were entering the fray.
Comparatively, the volume has been tiny over the past three sessions of selling. Bears are phoning it in, and the downturn lacks teeth. This should make it easier for prices to find support near here and bounce.
The best-case scenario is to have support form near $47.50 to keep prices above the rising 20-day moving average and old resistance. That said, we could push as low as $46 before I’d abandon my dip-buying desires.
Implied volatility edged higher over the past three sessions, but it’s not really high enough to make selling premium tempting. So instead, let’s go with a call spread. The cheap price tag works to the advantage of a call diagonal.
The Trade: Buy the November $45 call while selling the September $50 call for around $4.20.
The max loss is limited to the initial trade cost of $4.20. If you exit when WFC breaks below $45, it should reduce the loss to around $1.50. On the positive side, if WFC stock pushes up toward $50 or above near September expiration, you should capture a gain around $1 to $1.50.
On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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