2nd Update: BAC and the Mother of All Black Swan Trade Structures

by Dan September 22, 2011 3:30 pm • Commentary

Update Sept 22nd, 2011: With the stock at 6.00 I just bought back 1 of the Jan12 2.5 Puts for .16….Now I am long the Jan12 5/2.25 put spread for .28 (original .12 debit plus the .16 I just paid to cover 1 Put) and the spread can be sold at .56…..I want to let this spread ride as I think there is a very good chance that the stock goes to 5.00 in the coming weeks…..

Update Aug 8th 2011:  BAC is trading down about 9% since I priced this trade up Friday afternoon and frankly if this structure interests you than you should probably wait for a bounce to put this on.  You also want to be very careful about using limits and decide the probability of this ratio spread being in the money and how much you are willing to risk.  When I priced this Friday afternoon with stock ~8.25 this cost ~.12, now with stock much lower the risk/reward profile changes dramatically.  You should wait to do this on a bounce in the stock. 

Original Post Aug 5th, 2011:

BAC ($8.25) had come a long way from the 2009 lows and large hedge funds profited being long the name off of the bottom and the Govts exit from TARP in late 2009 into 2010.

-But 2011 has been a rough year for the stock taking it back to levels not seen since 2009 at the height of the financial crisis.  The stock is currently down 39% ytd and 46% off of this years high……  [private]

-Trading in downside puts have been brisk in the name and most days recently they top the most active options in the entire market.  For instance today’s most active single stock option is the BAC jan12 7.5 put which has traded 62,000.

I want to put on a very low probability trade that has a massive payout with no tail risk if the financial world as we know it comes to an end……again.

Or If you are long, this trade structure can be a cheap form of doomsday protection.

TRADE:   BAC $8.25 BUY JAN 5 / 2.5 1×2 Put Spread for .12

-Buy 1 Jan 5 Put for .34

-Sell 2 Jan 2.5 Puts at .24 (.12 each)

Break-Even On Jan Expiration:

Loses: Above 5 lose .10 premium, btwn 4.90 and 5 lose up to .10 and btwn .10 and zero lose .10…

Profit: Stock btwn 5 and 2.50 make up to 2.40, Best Case stock is 2.50 and u make 2.40, payout trails off below 2.50 and zero but u essentially cant lose more than the premium that you spent because the stock can’t go below zero!


In this environment especially investors are looking for cheap hedges or “black swan” protection.  This trade structure could be a very cheap form of protection against a long if you were worried about the very small chance that BAC could go the way of LEH (which I don’t think it is very likely).

Remember there is a very strong likelihood that this trade loses money on Jan expiration as the Jan 5 Put only has a 13 delta to it, so the options market is essentially say that there is only a 13% chance that the option is in the money.

On a mark to market basis, there is a very good chance though that prior to Jan expiration that this trade is up money if the stock continues to plummet lower.

Also this is a unique structure where you are taking advanatge of the elevated vol without the risk of being short a tail.