Schwab is a great play when financial uncertainty grips the market.

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Schwab is a great play when financial uncertainty grips the market.

Julian Close 10/14/2013

The financial sector was largely blamed-and not without justification-for the financial crisis of 2008, but with a few exceptions, most financial institutions weathered the storm better than the rest of us, which is to say that most of them are long since back to trading at record highs and making record profits, while the broader economy is still struggling with distressing levels of unemployment and underemployment.

One piece of the economy that has recovered quite nicely is the stock market, and the rising stock market has done even more to increase the profits of large brokerages. Still, many investors have come to feel that they cannot trust big financial companies in good times or bad, and are too resentful of the damage done to want to put their own money into financial stocks. Fortunately, not all companies that benefit from the rising stock market had anything to do with the investment banking scandals that brought down the economy in 2008. One such relatively innocent beneficiary is Charles Schwab ( SCHW ).

I've been around long enough to remember Schwab when it was the discount broker. Though it seems hard to fathom today, there was a time when those who were not in the industry had no real option for buying stock at a low-transaction cost. Investors simply had to negotiate with their brokers, and the brokers had an overwhelming advantage. By allowing self-directed investors to trade their own stocks at low cost, Schwab very much let a genie out of the bottle, and today, Schwab does not even try to compete on price against the ultra-low cost brokerages.

Instead, Schwab decided to provide more of a human touch to their discount trading, and eventually began offering financial advice to clients who desired it. That was a good decision, as Schwab's financial advisory segment now brings in 40% of the company's revenue. While revenue from trading continues to fall, analysts nonetheless predict single digit earnings and revenue growth in 2013 and 2014.

SCHW stock was, unsurprisingly, a big winner during the first half of the year, rising from just over $15 to a high of $22.69 while paying a small dividend. Also unsurprisingly, the stock ran into trouble in the summer, as the market became choppy, and has traded recently around the $21 level. Because Schwab doesn't make its money by charging large commissions on each trade, it does not experience as large a revenue boost from more active trading as full-service brokers do. In the long run, however, market choppiness is a good thing for Schwab, as customers of full-service brokers frequently notice how much they are really paying in commissions only when the market retrenches, and Schwab's low-cost / competent-advice model should therefore appear more attractive.

Given the company's history, its client-focused approach, and the need for investors to find safe-havens as the financial markets grow more volatile, the chance of any significant, near-term drop in the price of SCHW stock appears remote.


Chart courtesy of www.stockcharts.com .

I seek to capitalize on this strength with a bull-put credit spread. Look at the December 17/19 bull-put spread for at least an $0.20 credit. This trade has a target return of 11.1% over 69 days, which is an annualized return of 58.8%, (for comparison purposes only) and the stock has to fall 11.2% to cause a problem. Be aware that this is an aggressive trade, best undertaken by investors with diverse portfolios and high tolerance for risk.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Originally published on InvestorsObserver.com


This article appears in: Investing , Options

Referenced Stocks: SCHW

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