Safely Trade Bank of America Corp (BAC) Stock in This Schizophrenic Market
The Financial Select Sector SPDR Fund (NYSEARCA:XLF) is up 33% in one year, but this is nothing compared to the Bank of America Corp (NYSE:BAC) stock rally. Coming into its earnings, BAC was up a staggering 58% in 12 months. This seems to a bit overdone, as they say too far too fast but not if you look at the financial metrics.
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The rally in banks was fueled by promises from the Donald Trump administration and the prospect of higher rates. In reality, banks like BAC shored up their balance sheets, and so they are now allowed to participate in financial engineering.
This is important to my thesis, as I will rely on their actions to defend my trade.
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Fundamentally, BAC stock is not expensive. It sells at 15 price-to-earnings ratio and par book value. It pays a dividend to boot, so it’s not a mistake to buy it at a discount.
The earnings results this morning met expectations and traders are buying it up a little. This is a much better reaction than Citigroup Inc (NYSE:C) yesterday. BAC did not have the same provisions for credit card losses.
Regardless of what Wall Street does, I see value in BAC so I go long confidently using options.
But it all comes down to expectations. Sometimes the theme we are all chasing is so good that we end up expecting the impossible. And when the results come out they are almost sure to create a temporary let-down. Key term here being “temporarily” and therein lies my opportunity.
Even though I have been bullish BAC stock under these conditions, I expected setbacks so I make room for them.
Technically, the picture for BAC stock changes drastically based on time frame. On the daily chart it looks like it’s long in the tooth. Whereas the monthly chart shows that the long term recovery is still ongoing. So I will stick to the fundamentals and trade against the current tangible value.
Today I want to bet on proven support. I have already done this several times in the past few months and without much trouble. My strategy is different than the typical buy-and-hope where I would need a rally to profit. My setups would pay me even if Bank of America stock falls another 15% from today.
To accomplish this, I use options where I can choose where I want to own the shares. Then I sell the risk to open and let time do the rest. This creates income from nothing.
BAC Stock Trade Idea
The Trade: Sell the BAC Apr 2018 $22 naked put and collect 70 cents. In this bullish trade there I have an 80% theoretical chance of success. But if the BAC stock price falls below it, then I own the shares and would accrue losses below $21.30.
If selling naked puts is too much risk then I could sell a spread instead. Selling spreads greatly reduces the maximum potential loss.
The Alternate Trade: Sell the BAC Apr 2018 $22/$20 bull put spread which would deliver 15% in yield. Both trades have about the same odds of winning.
Neither set ups requires a rally to profit and they both have a sizable moat around my risk. Compare this with buying shares with no room for error.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.
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