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Option trader Jared Woodard of CondorOptions.com offers a trade idea based on one of the cheapest options in the Eurostoxx 50, with a historically flat implied volatility skew, to boot.

After being down nearly 20% over the summer, Barclays (BCS) shares have rallied steadily through the fall and are set to close the year with a 35% gain. In spite of recent performance, the bank is still trading at a 25% discount to its peers. Improving fundamentals and historically cheap option implied volatility make upside call spreads look attractive through January.

Fig. 1. Barclays PLC ADR (BCS) and Financial Sector SPDR (XLF), 2012. Source: Yahoo!
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With much of the UK still mired in a fog of voluntary austerity, the prospects for major banks there have not been that bright, but Funding for Lending Scheme (FLS) data from the Bank of England released last week showed that Barclays drew £1bn in FLS funding, which should have a positive impact on margins; in a note on the data, Deutsche Bank analysts commented that, “We do not expect banks to use much funding, which they cannot demonstrate has been passed to customers.” Banks generally have plenty of liquidity, but in addition to its titular purpose, FLS allows banks to replace more expensive wholesale funding with cheaper liquidity from the central bank. Barclays’ net lending of 3.8bn puts it ahead of the other FLS participants.

Fig. 2. Participating FLS institutions. Source: Deutsche Bank, Bank of England
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J.P. Morgan upgraded the stock to overweight in a longer report in late November, citing improvements in capital pressure from regulators and the potential for a much higher valuation if the company restructures its investment banking division. On the possibility that a restructuring might be announced at or before the investor day in February, JPM suggested February call spreads to participate in a likely grind higher.

BCS options are prima facie attractive, anyway, as they are among the cheapest in the Eurostoxx 50 on a one-year percentile basis (fig. 3).

Fig. 3. Eurostoxx 50 cheap volatility. Source: Santander
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Additionally, the implied volatility skew is historically very flat, with three-month skew near a five-year low. That means investors can collect a worthwhile premium on OTM calls without giving up too much in terms of expected price appreciation.

Fig. 4. Barclays 3-month implied volatility skew. Source: J.P. Morgan
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The US-listed Barclays ADR does not yet have February options listed, but the January series is about 40 days from expiration and will provide decent exposure. Investors could recently buy the 16/17.5 call vertical spread for about $0.60.

By Jared Woodard of CondorOptions.com