An aggressive put options trade in Bank of America Corporation (NYSE: BAC) Friday prompted Barron’s to run an article titled, “Could BofA Shares Fall to $2.50?” Had everyone taken this article at face value, it could have been a disaster for Bank of America’s stock price.
First and foremost, the article was not exactly predicting a $2.50 share price; rather it was talking around it. It noted that 160,000 BAC Nov 10 Puts were traded at 12 cents by an unidentified investor, which was likely a hedge.
Where the article gets interesting is when Barron’s said, “According to trading patterns, some options traders are betting that BofA’s $11 stock could fall to $2.50 by 2013.” It went on to note that the trading activity in BAC LEAPS has been active since Tuesday, specifically mentioning the BAC Jan 2012 2.50 Puts, which it said was a speculative trade.
Trading long-dated and far-out-of-the-money puts or calls is not a sniper’s approach. Picking an option and a strike price for the end of a week or even the end of a month requires an accurate forecast and an accurate reaction to an event or series of events.
A 2.50 strike put option with two years and change to expiration when shares are around $11 is a cannon shot approach, aiming way out on the horizon and merely hoping you come remotely close to hitting a strategic target. If BAC shares were to fall to $7 in the next few months, those put options would be worth significantly more than when they were when purchased.
For BAC to actually hit $2.50, its Countrywide acquisition would have to turn the firm into a Lehman or Bear Stearns. In short, they’d be talking about bankruptcy risks. The debate is still out over whether BAC will even have to take back any mortgages. After all, Countrywide was acquired after many of the mortgages were made. There are still many variables to consider. Some feel that the bank’s structure has protection from the Countrywide operations, and some feel that BAC as a whole could have to absorb all of the losses tied to the past directly. Time will tell.
So making a $2.50 put options bet may seem extreme, but it is not out of the realm of possibility. And BAC is not the only stock that sees such speculative action. The SPDR Gold Shares (NYSE: GLD) is ofte active in the far-out-of-the-money strikes that would imply gold prices hitting $2,000 in 2011. This is just traders trying to get exposure to big moves in the commodity over a set period of time. Apple Inc. (NASDAQ: AAPL) options experience similar action. And on any given day, you will see the occasional January 2012 $1 strike puts and $10 strike calls trade in Citigroup, Inc. (NYSE: C).
Of course, trades like the 160,000 BAC Nov 2.50 Puts stand out, and Barron’s is often called the “financial Bible,” so a headline like that carries some weight. Bank of America shares hit a new 52-week low of $11.12 today, but the shares were marginally positive at the open. If there were serious and legitimate concerns that BAC would see $2.50, those shares might have been down closer to 10% today.
Follow Jon Ogg on Twitter @jonogg.
