BofA – BAC Pain

by CC July 11, 2016 2:45 pm • Commentary• Trade Ideas

A couple of weeks ago we expressed our gloomy view of U.S. bank stocks with a put purchase in Bank of America (BAC ) expiring in August. We chose that expiration because it captures BAC’s earnings on July 18th and gives us enough time to absorb the continuing rally following the Brexit head fake lower. Here was the original trade and rationale:

*Trade: BAC ($13.10) Buy August 13 put for 53 cents

Rationale: BAC was $12.05 on Monday afternoon, the stock has benefited from the stabilization in European stocks and the news around the Fed’s Stress tests, but the under-performance of Euro banks from Monday’s lows, and the sharp drop in Treasury yields suggests to me that the lows are not in for bank stock’s this summer. This a defined risk way to get very near the money participation to the downside.

Our view remains the same. The main thrust of the thesis is that the current rate environment will remain a drag for banks, and that’s only reinforced on this broader market rally by the weak bounce we’ve seen from European peers like Deutsche Bank (DB):

[caption id="attachment_64914" align="aligncenter" width="655"]Screen Shot 2016-07-11 at 12.14.40 PM 1 yr DB[/caption]

So BAC has the same exposure as U.S. banking peers when it comes to the rate and regulatory environment, and they have out-sized exposure to Europe where as we can see from DB, it seems that things still aren’t hunky dory.

But BAC earnings are coming up, and we’re losing on the original premium on both decay and delta drift. So we’ll have some decisions to make before the 18th.

With the stock at 13.25 the puts we paid 0.53 for are worth 0.36. So we need to be careful of the stock continues to drift higher. The 50 day moving average resistance sits at 14 and that wouldn’t be a great spot to own 13 puts into an event as our breakeven would be so far out of the money. So we really need this closer to 13 into the event in order to stock around. If it was 13 we’d possible even have the opportunity to spread to reduce premium risk. Above, we’d probably keep it to about a 50% stop loss on the .53 paid, so any move higher from here above 13.50 and we’d likely pull the plug and look for a better opportunity. And all of that depends on what we see in interest rates and the situation in Europe as the narrative could quickly change.

We’ll update either way before the event itself.