OptionPundit

Tag: Bank of America

  • Bank of America (BAC) : A Speculative Trade

    Before I start the post, let me warn that trading into financial is full of risks and you may lose your capital. You should make sure that you have a proper risk management plan in place to handle this and should only invest what you might be willing to lose 100%. And this particular trade you should not try if you think BAC is headed for bankruptcy/ nationalization, wiping out shareholder’s equity. (As a general suggestion, one should never invest more than 2-3% into any speculative trade. A good money management is extremely important as these have high risk for losing capital.)

    There are some bearish news on BAC. According to Oppenheimer & Co,  Bank of America Corp., the largest U.S. bank, needs to raise $36.6 billion in equity to bring capital ratios in line with its peers. The news has driven IV higher. In any case IVs were already high on BAC and other financial stocks.

    (You may want to sign-up for the Basic Membership (Free until Dec 2009) that I use to share free trade alerts for registered members)

    So how to play a possible speculative trade on this-

    bac-75-long-calendarI am opening a LEAP calendar spread on this. Which is BUY TO OPEN Jan 11 7.5 calls for $3.5 and SELL TO OPEN May 7.5 ATM calls for 1.13, netting only $2.35/spread. I am treating it as covered call which means I shall continue to write ATM/OTM calls against my leap. I need to roll it only almost 2-3 more times to get back my cost. If however by May expiration, BAC continues to hover around 7.5, the returns will be > +40%. However the chances of staying flat are very dim. The trade has $5.8 and 12.4 as break even points by May expiration as per current IV profile. After 2-3months, LEAPS are free for remainder of the life assuming BAC doesn’t file for bankruptcy or for nationalization and hence the risk.

    So the chance of making money for this trade is only under “No Nationalization” or any other ” Significantly Bad News” thus causing the stock to drop to peanuts; even if it drops to the levels we saw earlier i.e. $2.5 or so, I expect near month ATM to generate $0.30 to $0.50 thus breaking even in a few months. It will be free thereafter.

    Net, if the conditions remains either as now or better, this trade may make money (If it does deliver +20% or so quickly, I may just get out completely). If conditions are bad, this may still make money, but if conditions are worst i.e. nationalization/Bankruptcy etc, it will lose money. You may also want to stress test for various IV profiles.

    Disclaimer– As of this writing I own this spread. I may change my position anytime without notice.

  • Are you Prepared for the Next Leg

    I don’t think 8,000 is far for Dow! Yes, that’s a grim forecast but not something unrealistic. I shall be publishing rationale for this via a special report.

    You may follow my thoughts at InvesCafe, a micro blogging investment portal something like twitter but focused towards investing and finance.

    An almost 400points u-turn in the last few hours, what was that? short covering, maybe. But I guess the hopes and dreams are running high in anticipation of interest rate cuts. Probably global interest rate cuts. Australia has cut rates by full 100 basis points, the biggest single cut since 1992, and western governments and central banks now face demands for coordinated action for rate cuts.

    How worse it gets if there is a national bankruptcy. According to Wall Street Journal, Iceland was at risk of “national bankruptcy,” Prime Minister Geir Haarde said and prepared to give regulators authority to take over the nation’s ailing banks as a worsening financial crisis all but cut off the island from the global financial system. Iceland agreed to adopt sweeping powers over banks on Monday as its financial system tottered, its currency plunged 30 percent and a leading agency cut its credit ratings.

    Although Royal Bank of Scotland Analysts, Bob Janjuah, correctly predicted the fate of stock markets, he overlooked the fate of his own bank. According to Bloomberg, the U.K. government may invest at least 45 billion pounds ($79 billion) in banks including Royal Bank of Scotland Group Plc and Barclays Plc to bolster capital depleted by mortgage-related losses, two people with knowledge of the situation said. And by the way, the RBS stock has plummeted by more than half since his prophetic prediction about the markets.

    According to the Bloomberg again, The Federal Reserve may have trimmed borrowing costs yesterday without actually saying so. The central bank used power granted under last week’s financial-rescue legislation to effectively set a floor under its main interest rate that’s lower than the 2 percent target set by policy makers last month. The Fed may now pay interest on bank reserves while it floods financial markets with liquidity, pushing down the overnight lending rate by about 0.75 percentage points to 1.25 percent. This move enables the Fed to expand the liquidity facilities to whatever size they wish without depleting the Fed balance sheet which now has only about $200 bln of treasuries left on it. Read more here.

    And hello B of A, what happened to The King. “The recession is going to be a little deeper than we thought,” Lewis said on a conference call. “It’s going to take some more time and some more pain.’ Bank of America Corp., the lender that is buying Merrill Lynch & Co., is preparing for a weaker economy by slashing its dividend in half and raising at least $10 billion in a sale of common stock. The dividend was cut to 32 cents a share, the Charlotte, North Carolina-based bank said yesterday. Chief Executive Officer Kenneth Lewis said the U.S. economy slowed in the past 45 days with little prospect for immediate improvement.

    Bank of America announced its third-quarter earnings two weeks early. Profit dropped 68 percent to $1.18 billion, or 15 cents a share, in the quarter ended Sept. 30, from $3.7 billion, or 82 cents, a year earlier. Analysts predicted profit of 61 cents a share for the quarter, the average of 20 estimates compiled by Bloomberg.

    And inspite of trillion $$ bail-outs, The Ted spread is still not retreating. It’s painful for the financial systems. And my worry is now about Corporate America. If Banks can’t borrow from each other, how will small to medium and in fact large companies will survive whose daily operations are dependent on revolving credit line. Here is an example. Banks and investors who are losing money on the record $1.7 trillion of high-yield, high-risk loans made in 2006 and 2007 are charging borrowers an average of 1.64 percentage points more in interest to amend borrowing agreements and avoid default, according to Standard & Poor’s. That’s the highest since 1997 and almost eight times more than the first half of last year. 

    According to Forbes, The South Korean won dropped as much as 5.7 percent against the dollar early on Tuesday to its weakest in seven and a half years on persistent worries about the credit crunch and a global economic slowdown, despite assurances from the government that Asia’s fourth-largest economy was not facing a currency crisis.

    The Reserve Bank of India announced that it has decided to reduce the cash-reserve ratio by half a percentage point to 8.5%, beginning Saturday. Thus allowing banks to pump liquidity into the markets. The action will release about 200 billion rupees ($4.2 billion) into the country’s financial system.

    That’s how grim the market sentiments are, but do remember many of the past bull markets started even in grimmer environment. 

    More to come. Follow for real-time commentary at InvesCafe.

    Profitable trading, OP