Deutsche Bank’s Woes: Will Germany’s Sick Man Infect Global Markets?

Options investors bet that battered stock will keep falling. Bank’s problems include possibility of huge fine from U.S. regulators.

By Steven M. Sears
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Co-chairman of Germany's biggest lender Deutsche Bank, John Cryan, at the company's annual shareholders' meeting in May. Photo: Agence France-Presse/Getty Images


Does the black swan speak German?
 
It’s a question worth pondering, as investors wager that Deutsche Bank might be unable to cure itself of a litany of woes that this year have nearly cut its stock price in half.
 
The bank’s challenges are immense. They range from restructuring operations and modernizing infrastructure to reducing balance-sheet risk and trying to negotiate a reduction in a U.S. fine that could run as high as $14 billion.
 
In totality, those challenges are arguably more menacing to the global markets’ stability than the Federal Reserve decision on whether to raise interest rates by a quarter-percentage point, or whether Hillary Clinton or Donald Trump becomes the next U.S. president.
 
A SMALL RATE HIKE should be easily digestible, even if it would initially disrupt the financial market’s post-crisis high. The American political system has been dysfunctional for so long that the election should be a non-event, especially if Congress remains gridlocked, which would checkmate the White House, regardless of who’s in it. But Deutsche Bank is deeply intertwined with the global capital markets. If it can’t cure itself, it could infect the markets or weaken already wobbly investor confidence.
 
Those overhangs have many investors viewing the German giant with extreme mistrust. Even though they have humiliated the stock (ticker: DB), they could inflict still more misery on it. From a technical viewpoint, the stock chart seems to be indicating that a new 52-week low is near. Over the past year, the share price, recently around $13, has ranged from $12.43 to $30.82.
 
“The European Central Bank, through negative interest rates, has essentially made it impossible for Deutsche Bank to make money. And the U.S. government has thrown them a fine” tied to a probe of mortgage-securities “that is essentially greater than their market cap of 14.4 billion euros [$16.4 billion],” one of the Street’s top financial traders says.
 
John Cryan, the bank’s CEO, has a monumental task. He reportedly explored a merger with Commerzbank(CRZBY), Germany’s second-largest bank, but that led nowhere. Some investors fear Germany’s once mighty No. 1 bank might be forced to raise money, by issuing more stock or taking on debt, to enhance operations. 
 
“Deutsche Bank has seen among the weakest earnings momentum in the sector, as falling global fee pools and deleveraging have weighed on revenues, and high restructuring and litigation charges have weighed on costs,” John Pease, a Credit Suisse bank analyst, recently told clients.
 
OPTIONS TRADING PATTERNS show that investors largely are betting that the stock collapses.
 
The most widely-held positions include some 46,000 January 5 puts, about 34,000 January 13 puts that expire in 2018, and 30,000 January 10 puts. Last week, investors bought January $5 puts that expire in 2018, and December $12 puts.
 
Of course, it is hard to know if the stock will tumble as sharply as anticipated by the downside puts.
 
The January 5 puts that expire in 2017 are offered around 10 cents. If the stock falls to $4, they’re worth $1.
 
Risking 10 cents to make $1 could produce a phenomenal return. Should the stock never trade below $5, the trade will fail, but who cares that much on a 10-cent contract?
 
Whether you buy Deutsche Bank’s $5-strike puts is perhaps immaterial. What is material is that Deutsche Bank’s difficulties are a reminder, in an uncertain season, that the real risks are usually rarely discussed in the media. Trade it or fade it, but add the German institution’s stock ticker to your trading screen, right next to the VIX.
 
In short, Deutsche Bank is a tier-one risk factor.


 
STEVEN SEARS is the author of The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails.

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