Bank of America Corp (BAC) stock rose 3% on Friday on better-than-expected October U.S. labor data. This comes after equity markets rebounded sharply off the August correction lows, mostly on the back of Federal Reserve Chairwoman Janet Yellen expressing the delay of the rate hike due to heavy global concerns. As a result, markets priced out the possibility of a 2015 rate hike.
However, the October jobs report released on Nov. 5 showed economic strength well beyond expectations, so the December rate hike is now back as a strong possibility.
Equity markets in general react negatively to rising rates, but one exception is financial stocks, which rose sharply on the jobs report. The general rule is that banks — BAC stock included — do better in rising-rate environments.
Traders are now faced with the temptation of chasing spikes.
As a general rule, chasing prices blindly often results in losses for the late comers as they end up buying other traders’ profits. Unless a trader is already long financials, buying them here in size could prove costly. Sure, a starter position in BAC stock would be acceptable, but patience may prove more prudent.
This year, if anything, proved that “this time is different.” So, the long BAC stock trade from here might not be as sure a thing as the consensus suggests. Furthermore, markets have been obsessed with the date of the rate hike; hence it is logical to assume that it will actually be a headwind for equities. It also would be reasonable to assume that, after the initial pop, the financials will eventually fall in line to trade with the general market direction, meaning the outperformance should eventually abate.
Here are a few options trade ideas on Bank of America for those who want to take a contrarian view of financials’ rally from here:
Shorting equities using options is much easier and relatively safer than shorting equities outright. Buying puts or put spreads is generally the preferred method by most retail options traders. Selling call spreads (credit call spreads) is another way, but it requires more expertise and control.
Bank of America was trading at $17.98 as of this writing. Buying put spreads here would come at a discount. However, traders are better served to choose a contract with some time on the clock. BAC stock still shows open interest support through this week around $14/$15 area. The November monthly OI shows resistance above $18. Given this information, chasing prices from here is dangerous.
A trade with decent profit potential is to buy December puts at the $17 strike. To lessen the risk, traders could buy a put spread. So instead of buying the $17 put alone, they also would sell the $16 put to limit the entry cost from 27 cents per contract to 17 cents per contract. This would be the maximum loss. The downside to this would be limiting the potential profits to a maximum of 83 cents per contract. Those who buy the puts profit if prices fall before the expiration date. Time is the enemy, so higher losses would be incurred if prices hold high or move higher. If prices fall, then profits will accumulate rapidly. The trades can be reversed to exit at any point in time.
Brave active traders could try selling call spreads to finance the purchased puts, but the most conservative traders looking to short this pop would be better served taking put spreads.
Here are a couple of other ways to short BAC stock from here:
- Going shorter in time for a faster alternative, which puts less money at risk but is more sensitive to price movements: Buying the Nov 27 expiration $17 BAC put for 11 cents per contract cost
- Going farther out in time for a slower alternative, which puts more money at risk but is less susceptible to fast losses: Buying the Jan 2016 monthly $17 strike put for 40 cents per contract
As of this writing, Nicolas Chahine did not hold a position in any of the aforementioned securities.
