BAC has fallen more than a dollar since we put on a long put trade in the stock a couple weeks ago. In our Considering Our Options post last week, we noted that we were going to give the BAC a chance to break the $15 level. That occurred this week, but the stock is moving back above the $15 level today, so we are going to take our gains on this trade for a triple.
Action: BAC ($15.01) Sold to Close May17th 16 Puts at $0.99 for a $0.66 gain
Previous Post, April 28, 2014 – Considering Our Options: How to Manage Long BAC Puts
BAC announced this morning that it was suspending its planned buybacks and dividend increase because the Federal Reserve was asking that BAC re-submit its capital plans after finding an error in its accounting of structured notes, which reduced its prior regulatory capital levels. The stock is down about 5%
We put on the following bearish trade in BAC a week ago (full post below):
TRADE: Buy to open the BAC ($16.10) May17th 16 puts for $0.33
The market reacted severely to Citigroup’s failure of the stress test. Today’s announcement from BAC is in the same league, and possibly worse, since it indicates that management does not have a good grasp of where to mark its securities positions. That’s a huge concern for a bank of BAC’s size, particularly if an error forces the bank to suspend its buyback.
BAC has broken multiple short-term support levels with today’s gap down. First, it is trading below its 200 day moving average (currently around $15.46) for the first time since August 2012:
BAC daily chart, 200 day moving average in yellow, Courtesy of Bloomberg
Second, BAC is now red on the year for the first time in 2014 (it closed 2013 at $15.51).
Below here, the first support to watch is the December low around $15. Below there, the November low was near $14. Relatively simple, big figure support levels.
So what do we plan to do with our long May17th 16 put?
Sometimes, bad headlines are not really that bad, and sometimes bad headlines are really bad. Our first reaction to this one was the latter. This is a serious matter for BAC, and we expect some investors to totally exit the stock on such news.
Since the headline is important, I expect BAC to struggle to get above the prior support area of $15.40 to $15.60 in the coming weeks. Currently, the May17th 16 put is worth around $0.92 with the stock around $15.20, so there is about $0.12 of intrinsic value still in the puts.
Here are a few options for managing this position:
- Spread the puts – Selling the May17th 15 puts at $0.27 or the May17th 14 puts at $0.05 would reduce some of the cost basis of the trade. In the case of the May17th 15 puts, we would have the May17th 16 / 15 put spread on for $0.06, with a max possible gain of $1. Given the large, long-term technical breakdown, it does not seem worth it to sell the May17th 14 puts at $0.05.
- Sell half of the position to lock in a profit – Since our cost basis is $0.33, selling half of the May17th 16 puts at $0.92 would mean that we would have locked in a profit on our original position of $0.13. We could let the balance ride, targeting the $14 support area to take off the balance.
- Sell the full position for a profit – This trade is almost a triple, and in our experience it usually pays to take off options trades that have more than doubled in a short period. However, I’m leaning towards holding on to some exposure in BAC’s case since this news is so jarring, and the technical breakdown today through support is quite important to accompany the bad news.
Put it all together, and we’re going to hang on to the position for now, though we might look to take profits in some fashion near the $15 support level.
Original Post, April 21, 2014: New Trade – Back to BAC
I detailed the key takeaways from the large bank earnings reports in Thursday morning’s Macro Wrap post. It was a mixed bag, but Bank of America was particularly interesting to me for several reasons. First here were the BAC bullets from that post:
- Biggest headline hit was due to legal costs related to its mortgage business, and management indicated that future legal costs could still be “lump” in their words
- Mortgage business was also a weak spot for BAC, though the fixed income business was better than peers (down only 2% year-over-year)
- The slowing reserve release pace mirrors JPM more than WFC, which could be a concern for BAC earnings projections going forward.
Of the large bank stocks, C and MS had the best all around reports, while JPM and BAC were on the weak end of the spectrum. While the market punished JPM for its missteps (stock is trading near 5 month lows), BAC held up much better despite a weak overall report, particularly the slowing reserve release and the potential for further legal losses going forward.
Meanwhile, analyst expectations for BAC in 2015 and 2016 are much higher than for any of the other bank stocks. Analysts have modeled in $1.59 in EPS in 2015 and $1.81 in EPS in 2016 for BAC, vs. only $1.04 in 2014. Most of BAC’s peers only have earnings growth expectations of 5-10% over the next couple years. A big reason for the jump is BAC’s continued restructuring program, but that’s an awfully large jump for a company that did not sound too optimistic on the earnings call last week.
BAC has fought to stay above its $16 support level over the past week:
BAC closed 2013 at $15.57, and the stock has remained positive year-to-date throughout 2014, with last week’s low of $15.62 just above the unchanged mark on the year. The rising 200 day moving average, which has not been breached in more than a year, is now around $15.40. So the $15.40-$15.60 area is crucial support for BAC going forward.
While the stock battles to hold support after the weakness of the past month, implied volatility is still quite low relative to the past 2 years:
Granted, the stock has no major events upcoming in the next month, but the recent volatility on the stock’s selloff has registered little concern in the options market.
Cheap options pricing for a stock perched on support after a weak earnings report and very high expectations going forward presents an opportunity for a put trade to play for more selling in the coming month:
TRADE: Buy to open the BAC ($16.10) May17th 16 puts for $0.33
Break-even on May17th expiration:
Profits: below $15.67
Losses: of up to 0.33 between $15.67 and $16.00, full loss of 0.33 at $16.00 or above
Since implied volatility is relatively low, we’d rather just buy an outright put than a spread, with the plan to spread or take off the position if BAC sells off to the $15.40-$15.60 support area over the next couple weeks. We will take the trade off for a loss if the premium gets to $0.15 or below.