The duration and magnitude of the rally back from the lows made on March 16th has caught some (namely ME) by surprise, as I have written on this site on numerous occasions over the last couple weeks, I think the market is severely mispricing a whole host of risks. That said, at this point it will take something monumental to avoid new 52 week highs which are only about 1% away.
There may still be some opportunities in some names to play catch up to the market or use the recently depressed vol levels to make directional bets………
I want to take a look at BAC which reports the day before April expiration on the morning of Apr 15 (pre-open). Stock generally not a huge mover on earnings with the average move over the last 8 qtrs ~3.25%. The 0ptions market is currently implying about a 3.5% move post earnings.
TECHNICALS: Below I have included 2 charts of BAC overlaid against the performance of the SPX. The first chart shows BAC’s performance vs the SPX since the start of the rally Sept 1, 2010. BAC for the most part tracked the performance of the index until very recently.
What I find most disturbing about this trend is that BAC is down about 5.5% since its March 10th close (the day before the Japan earthquake/tsunami) and has not rallied one bit with the index (see chart below) since bottoming on March 16th (stock is actually ~1% lower than Mar 16th).
This is the sort of price action I want to lean on a bit especially when you consider that there is an earnings event coming up……
-One potential reason for the under-performance was the government’s reluctance to let the company raise their dividend from the not so massive .01 a quarter while some of their peers were permitted to do so and re-initiate stock buybacks.
-Additionally, it has become a given in the market that trading volumes and advisory activities were on the slow side for the first 2 months of the year, and BAC”s own banking analyst downgraded and lowered estimates on C and GS on March 4th based on the following reasons:
From BAC note Mar 4, 2011:
Downgrading Citi and GS to Neutral. POs cut. Common denominator: expected weakness in Q1:11 results. Results unlikely to be dismal, and should show improvement over Q4, but we don’t expect seasonal improvement as strong as often seen in the past. Client engagement remains subdued, Mid-East turmoil likely only to further reduce customer risk appetite. Thus we are making significant cuts to our forecasts, and expect consensus to decline over the coming weeks. Increasingly, we believe investors will look to the theme of improving cash flow/return of capital via dividends/ buybacks, and also to play financials that are less–or even positively – affected by restrictions on banks such as Volcker Rules.
I would have to assume if their analyst was not working at BAC that he would have likely thrown BAC onto the heap with C and GS (he also lowered estimates but didn’t downgrade JPM and MS).
3 WAYS TO PLAY POTENTIAL VOLATILITY IN BAC PRIOR TO APR EXPIRATION:
1st. BUY APR STRANGLES
TRADE: BUY the APR 13 /14 strangle for .34
-Buy Apr 13 Put for .19 and
-Buy Apr 14 call for .15
Break-Evens on Apr Expiration:
Upside: stock stock 14.34 (up 6.5%) or higher you make $, btwn 14 and 14.34 you lose up to .34
Downside: stock 12.66 (down ~6%) or lower you make $, btwn 12.66 and 13 you lose up to .34
Worst Case: stock btwn 13 and 14 and you lose .34 premium you paid as both options that you are long will expire worthless.
-While normally the idea of buying 2 options with about 2 weeks to expiration would bring the owner the pain and sorrow of rapid decay, in this situation because earnings are the day before expiration, volatility in the name is likely to stay well bid and you basically have a free look at the next 2 weeks in the name…..
-this trade fits very well into my market thesis that we are very near an inflection point and that there is a strong likelihood that one of these options is in or near the money by the time the company reports and you will have this structure just where you want it in time for the earnings event..
2nd. Pick a Direction and BUY a Call or a Put
A. If you are of the mindset that the market will make new 52 week highs and continue the move higher and for this too happen it will need the participation of laggards, like BAC or GS (GS also below its Mar 1oth close), then outright Call purchase prior to earnings could be a relatively dollar cheap way to express that view, especially into a catalyst.
TRADE: BUY the APR 14 call for .15
Break-Even on Apr Expiration: stock 14.15 or higher (up 5%) you make money, btwn 14 and 14.15 you lose up to .15, and below 14 you lose all .15.
B. If you are of the mindset that this stock acts this poorly for a good reason and that the earnings announcement and q2 guidance will just reinforce the stocks under-performance, and that technically the stock is sitting on key support here resting on its 50 and 100 day moving average and a break below these levels probably sends the stock to 12.00 then consider buying April Puts as a dollar cheap way to express this view into the earnings catalyst.
TRADE: BUY the APR 13 Put for .19
Break-Even on Apr Expiration: Stock 12.81 or lower you make money, btwn 12.81 and 13 you lose up to .19, above 13 you lose the entire .19.
MY VIEW: First things first, this is a perfectly fine company, and in full disclosure, a former employer of mine. I am going to buy the Strangle this morning as I want to use this structure in a name that has an event as a sort of proxy for the potential market move that I expect in the coming weeks. For instance if the market continues to run I would expect BAC to finally participate as the rally broadens out, but if we see a retracement of the recent rally and a test of the March 16th lows prior to APR expiration I am fairly certain that BAC would perform badly and likely continue its under-performance. And at either point I still have the earnings event to possibly catalyze the stock.