I’m Buying Doug Kass’ Case for Schwab

Real Money writer Doug Kass made mention this week a few times that he is building up a position in Charles Schwab Corporation (SCHW) . The stock has dropped some 30% since the implosion earlier this month in Silicon Valley Bank (SIVB) .

I think Dougie is making more than a reasonable call here. I also took an initial stake in this well-known financial services and brokerage name this week as well. I did so, however, via a two step-option process that provides solid downside protection and should deliver a return in the mid-teens over the next six months even if the stocks declines a bit from current trading levels.

One thing I like about management of this company is they are stepping up and giving the shares a vote of confidence during its recent pullback. Insiders have purchased over $6 million shares in aggregate since SVB’s debacle. The difference between Schwab’s funding sources and Silicon Valley defines why the former is still functioning and the latter is out of business. Silicon Valley proudly boasted that it was the commercial banker for 44% of venture capital-backed health care and technology initial public offerings in 2022. As a result, the proceeds from the IPOs found their way into Silicon Valley Bank, whose saw its total deposits nearly quadruple in just four years. The company practiced extremely poor risk management, I believe, especially when it came to matching the duration of assets and liabilities. Something that ultimately led to downfall of the 16th largest bank by deposits.

With origins as a discount broker, Schwab primarily caters to retail clients, unlike Silicon Valley, which was a bank that serviced institutional customers such as tech, health care, wine, and private banking clients with typical account balances in the millions, much higher than the $250,000 covered by the Federal Deposit Insurance Corporation — the additional federal assistance post-crash notwithstanding. In one way, Charles Schwab benefited from Silicon Valley Bank’s downfall as it saw a $16.5 billion inflow of net new assets for the week ending March 17.

Schwab’s Available for sale, or AFS, portfolio has likely taken a decent hit since 2022. It still is in a strong liquidity position and can always access the recently established Bank Term Funding Program by the Federal Reserve, in response to this banking crisis, if need be. J.P. Morgan, Barclays and Citigroup all reiterated “Buy” and “Outperform” ratings on Schwab this week, and with the recent pullback the shares also yield nearly 2%.

Option Strategy:

Here is how I would open a small position in SCHW via covered call orders: Using the September $50 call strikes (approximately 6% below the current trading levels of the stock), fashion a covered call order with a net debit in the $43 to $43.20 a share range (net stock price – option premium). This strategy, including dividend payouts, provides downside protection of just 18%, with just slightly lower upside potential, even if the stock moves down 6% over the next half year. For those that want to protect this position from major financial contagion, also buying a September $30 put in the $1.25 to $1.35 range is recommended. This will lower your returns slightly but provides protection against a 2008 like scenario.