Bank of America A Cautious Way to Play A Potential Bottom, Without Limiting Upside

by Dan July 1, 2011 11:53 am • Commentary

There has been a lot of noise surrounding BAC of late…..largely to do with unhappy buyers of mortgage securities sold by the bank pre-financial crisis and a very large settlement that one very large shareholder of BAC encouraged management to oppose.  The irony is that the shareholder, John Paulson was the guy who made $20billion dollars shorting sub-prime securities in 2007/08.

Paulson started amassing his 123 million share position in BAC at the bottom of the financial crisis in early 2009 and likely bought a slug when the stock was still a hat size, but I suspect much of it came on the govt’s exit from their TARP holdings in 2 huge secondaries, the first in May 2009 at $10.77 a share and the other in Dec 2009 at $15.00 a share. Both offerings were greater than a BILLION shares each.  It has been rumored all year that he is sucking wind in his long bank holdings (which also includes Citi) which would obviously help explain both stocks’ under-performance since March.

WSJ reported today:

Paulson & Co. sold some shares in recent “weeks,” but now is trying to purchase more shares again, said a person close to the bank. A Paulson & Co spokesman said “we don’t comment on positions between public quarterly filings.”

It isn’t clear whether Mr. Paulson’s view of a settlement changed in recent months as the pact broadened, but the Paulson spokesman said in a statement that “we believe it is a positive that Bank of America is seeking to put legacy mortgage issues behind it so that investors can focus on the power of future earnings.”

This all sounds a bit peculiar, but if he sold a bunch and then is now buying it back you may want to get on board with him….If the selling by him and other large holders from the TARP deals throughout this past spring help push the stock to a few % off the near 2 year lows, then now could be a a good spot to take shot.  Sentiment in the name continues to be bad, and Wall Street analysts still fairly mixed with 20 Buys and 18 Holds.

Could there be more downside? No doubt about it, but if some of this weeks economic data becomes a trend and the economy picks up in the second half, the bank stocks which have seriously lagged will certainly start to participate.

Rather than Buying the stock here at $11.00 I want to look to a structure that gives me some leeway on the downside as we could see one more move lower in these names this summer.  I want to look out to November as it will catch 2 earnings announcements that could serve as a positive catalyst for the stock if in fact things are turning around.

TRADE:  BAC (11.00) Buy the Nov 9 / 12 Risk Reversal for .21

-Sell the Nov 9 Put at .26

-Buy the Nov 12 Call for .47

Break-Even on Nov Expiration:

Upside: btwn 12 and 12.21 (up 11%) lose up to .20, unlimited gains above 12.21

Downside: btwn 12 and 9 lose .21 and below 9 you are put the stock (down 18%) plus the .21 premium you paid…..

While this structure can be heavy on the margin requirement being naked short a put, it is not a much capital as if you were long the stock on a 100 delta, this structure has about a 50 delta but allows for a good bit of leverage on the upside and you have dramatically widened your downside break-even.


For those thinking of buying the stock right here and less worried about downside consider:

TRADE: BAC ($11.00) Buy NOV 10/12 RiskReversal for even money,

-Sell  Nov 10 put at .47 and

-Buy Nov 12 Call for .47….

Break-Even On Nov Expiration:

Upside: 12 and higher make money…

Downside: no loss btwn 12 and 10, but put the stock at 10.00 and lose money.