Bank Of America (BAC) Leverage

by riskreversal January 12, 2017 2:47 pm • Trade Ideas

Bank of America (BAC) reports Q4 results tomorrow before the open. The options market is implying about a 3.3% move tomorrow, which is rich to the 4 qtr one day average post earnings move of about 2.1%, but below the 10 year average move of about 4%.

Shares of BAC are up 3.5% in 2017, making it the only large money-center bank stock that is up on the year (C, JPM & WFC are all flat or down). Additionally, the stock’s 34% gains since November 8th makes it the best performing mega-cap bank or investment bank stock in the U.S., topping Goldman Sach’s 33% gains.

Taking a look at the 10 year chart, the November breakout at $19 was massive, dating back to the throes of the financial crisis. It was also important technical resistance from 2009, 2010, 2014 & 2015:

[caption id="attachment_69479" align="aligncenter" width="600"] BAC 10 year chart from Bloomberg[/caption]

There is little overhead resistance until $30.

Like the previous post in JPM, short dated options prices are fairly elevated relative to levels over the last year (30 day at the money implied volatility very near 52 week highs, blue below) and relative to realized volatility (white below, how much the stock has been moving):

[caption id="attachment_69480" align="aligncenter" width="600"] Bloomberg[/caption]

It could make sense to add some leverage in case the stock has a little more upside. 1×2 call spreads can be done for a few cents and can add quite a bit of leverage. For instance:

vs 100 shares of BAC (22.90) Buy the Feb 24/25 1×2 call spread for .06
  • Buy 1 Feb 24 call for .40
  • Sell 2 Feb 25 calls at .17 (.34 total)

Rationale – This adds up to .94 in additional gains of the stock goes above 24 and below 25 on February expiration. Above 25 you are called away in your long stock, but at an effective sale price of 25.94. If the stock is below 24 on February expiration you lose the .06 paid. These are nice overlays for people that would sell their stock a bit higher as it can raise the effective sale price before being called away. On issue with the 1×2 into an event with an expiration out more than a month though is that gains may not be immediately realized if the stock is higher. So patience is in order as the premium needs to decay (similar to an over-write). For those looking to leverage for the event only, the strikes need to be lower and narrower. For instance the the Jan 24/24.50 1×2 call spread is just .02 and adds up to .48 in leverage if the stock is at or above 24.50 next Friday. That’s also a nice trade but obviously lowers the effective sale price to 24.98, almost a dollar lower than the February 1×2.