Trade Ideas March 2, 2020

BAC Shot?

by Dan

If you have been following the stock market as long as I have you have heard all the goofy sayings more times than you want to remember, but it strikes me that one of the most quoted is from what many think is the best investor of the last. century, Warren Buffett:

Only when the tide goes out do you discover who’s been swimming naked.

This quote always struck a chord with me as he is suggesting that everyone is a genius in a bull market, and it’s in volatile times or bear markets where real investing acumen can be measured.

Volatile markets like the one we have now also reveal a lot about investor sentiment towards individual stocks and securities. For instance, today the S&P 500 (SPX) is up 2.4% as I write and the XLF, the S&P Financials Select etf that tracks U.S. Banks is up about as much, but interestingly, one of its largest components Bank of America (BAC) is unchanged on the day.

From purely a technical standpoint, the stock’s low this morning, which it has since rallied nearly 4% from, was a fairly significant long term support, the uptrend from the 2016 lows:

 

For those who think the worst may behind us with the coronavirus, and the stock market’s reaction to the measures taken to contain it are detached from economic reality, then leaning on a long-term technical level makes sense, but doing so with defined risk via long premium directional options strategies make it challenging. The chart below is the two year of 30-day at the money implied volatility, the price of options in BAC, showing its rise above levels in late 2018 when the stock was trying to find a bottom after a 31% peak to trough decline from its 52-week highs, vs its now 23% peak to trough decline:

 

If you are too look at the 6-month chart and see what I see, clear sailing to the upside IF, and its a big IF the market finds some calm, and fears of greater negative impact from the virus spreading abates, then the stock’s like BAC which might have just bounced off support should re-test recent breakdown levels:

But this is where the options thing gets hard… with the stock at $28.60, the April 29 – 32 call spread is offered at 95 cents, with a break-even up at $29.95 offering gains of up to 2.05 between 29.95 and 32 with max gain above $32. That is not a great risk-reward, risk one to maybe make two if the stock is up 12% in a month and a half. To get better risk-reward there is a tradeoff, you could start out by merely buying the long strike and looking to spread on a move higher, that way locking in some premium, but likely selling it at vol levels far lower than what you could have before the move,

On the flip-side, for those that think rates continue to tell the story, despite the stock’s markets gyrations, and the race to zero will continue to spook equity investors, and the virus persists in being a headwind to global growth, then a stock like BAC will surely break that uptrend from the 2016 lows and should be sold on rallies… but again, with BAC at $28.60, the April 28 – 25 put spread is offered at 85 cents, with a break-even down at $27.15, down about 5% with a max payout of $2.15, down 12.5% in six weeks.

But back to the ol’ swimming naked quote, if BAC continues to underperform the broad market and its banking peers, then it might make sense if the macro news does not get better to just lay into this one, playing for a re-test of the 2018 lows near $23.

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