Wells Fargo Stock Is Primed to Jump Higher. How to Play It.

Wells Fargo is experiencing a Lazarus-like moment that might lead to meaningful returns in 2023. The answer should come on Jan. 13, when the bank reports fourth-quarter earnings.

The report is poised to be a closely watched event—and not just because a major bank is releasing financial results and meeting with analysts just before the Federal Reserve’s interest-rate-setting committee convenes on Jan. 25.

Wells Fargo (ticker: WFC) has quietly become one of the most widely held stocks among mutual funds and hedge funds, which is an unusual situation.

Hedge funds are generally considered to be so-called fast-money investors. They want to quickly realize gains and will do so in any way possible. Mutual funds, conversely, are thought to be slow-money investors. They are often willing to patiently wait for companies with solid fundamentals to produce meaningful gains.

Those two investments styles might seem diametrically opposed, but a Goldman Sachs analysis of about $5 trillion of mutual fund and hedge fund positions has revealed that Wells Fargo is among the top holdings of both investment groups.

The appeal probably reflects an interest in Wells Fargo’s multiyear turnaround, which offers event-driven trading opportunities and the prospect of improving fundamentals—even as many investors fret that the economy could enter a recession that could create rough conditions for banks.

It now seems like a distant memory, but the bank was once one of Berkshire Hathaway CEO Warren Buffett’s favorite holdings. The legendary investor jettisoned his stake in Wells Fargo after the company’s fake-accounts scandal.

Since then, the bank’s shares have languished in the wilderness, even as its executives have worked hard to address its missteps and resurrect its reputation.

For aggressive investors, Wells Fargo’s broad ownership among hedge funds and mutual funds is an intriguing revelation, suggesting that January’s earnings report could act as a spring-loaded event.

A good report, and a positive outlook, would probably prompt hedge funds and mutual funds to push Wells Fargo’s prices even higher. A bad report could persuade long-term investors to abandon the stock—or to take advantage of any weakness in the stock if a case can be made that the outlook is reasonably bright.

It’s hard to anticipate the future, and many sophisticated investors feel that wagering on earnings reports carries equal odds of success or failure. But we know there is a lot of institutional money tied up in Wells Fargo, and that creates an interesting setup. In such instances, the institutional mob often moves in unison, and that often creates big moves.

With Wells Fargo stock at $42.45, aggressive investors—or patient ones—could sell the bearish January $40 put option and buy the bullish January $47.50 call option.

The “risk reversal”—that is, selling a put and buying a call with a higher strike price but the same expiration—pays investors to buy the stock at a lower price and to profit from any gains. The strategy generates a credit of about 20 cents. If Wells Fargo stock is at $52 at expiration, the call is worth $4.50.

The trade’s key risk is that the stock tumbles on earnings and falls far below the put strike price. If the stock is below the $40 strike price at expiration, investors are obligated to buy the stock or to adjust the put to avoid having to do so.

During the past 52 weeks, Wells Fargo stock has ranged from $36.54 to $60.30. Shares are down 12% this year, compared with a 17% decline for the S&P 500 index.

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Originally Posted December 8, 2022 – Wells Fargo Stock Is Primed to Jump Higher. How to Play It.

Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.