The market went on a tremendous run yesterday as the Financial stocks had a banner day after a good earnings report from Wells Fargo (WFC, $27.23, up $6.72). Many of the financial stocks that have been getting trounced came back strong as many investors are starting (or hoping) to believe the sector may have hit a bottom. The Dow ended the day up 276 points to 11,239, or 2.5%. The S&P 500 mirrored the Dow’s percentage gain as it closed 30 points higher to finish at 1,245. The Nasdaq posted the biggest gain, 3.1%, and closed at 2,284, up 69 points.

The turnaround in the market is amazing considering the Dow touched a low of 10,731 on Tuesday and has bounced 500 points off that low. The volatility has been so strong that you could have made a mint by buying some cheap calls on hopes that when Bernanke spoke the Financials would listen. And they did with the help of Wells Fargo.

We were stopped out of the Merrill Lynch (MER, $28.00, up $3.31) July 32.50 puts (MERSA, $4.75, down $2.85) as our $7.00 stop was hit. The puts were set to expire on Friday and by having our stop in place, it automatically took us out of the trade. The puts were profiled at an entry price of $2.15 so by having this stop in place you can see how we were protected.

Elsewhere, Wachovia (WB, $10.54, up $1.46) powered higher by 16%, Citigroup (C, $16.47, up $1.91) added 13%, while Fannie Mae (FNM, $9.25, up $2.18) and Freddie Mac (FRE, $6.83, up $1.57) each gained 30%. Goldman Sachs (GS, $172.86, up $15.06) also made a nice move after touching $152 on Tuesday. U.S. Bancorp (USB, $26.74, up $4.04) also rallied 18% despite reporting a bigger-than-expected drop in its earnings on Tuesday, as it tripled its provisions for loan losses. It’s hard to imagine after reporting such a lousy quarter the market would take USB that much higher but it did.

Let’s see how this plays out as Merrill Lynch and Citigroup are expected to report another quarterly loss today and Friday respectively. I believe we are at a point to where the Financial stocks are cheap but it could be two or three years before their earnings improve significantly.

As lottery plays you could keep these 2009 LEAP call options on your trading radar.

Citigroup January 20 call (CAD, $1.25, up $0.47)
Goldman Sachs January 260 calls (GPYAC, $1.07, up $0.28)
Merrill Lynch January 35 call (MERAG, $1.90, up $0.60)
Wachovia January 15 call (WBAC, $1.30, up $0.45)

We could see some banks get bought out and I think Wachovia could be the first to go. Again, these calls may get lower in price if the Financials do another U-turn and head south but with an average cost of about $125 per contract these calls will be a steal in six months if the Financials catch fire. Buy half now and if they go lower maybe buy the other half later.

Rick Rouse
Rick@OptionsMentoring.com