Financials have had a tough 2016 so far. The Financial Select Sector SPDR Fund (XLF) is down more than 3%. A particularly ailing bank is Bank of America Corp (BAC).
Click to Enlarge Year-to-date, BAC stock is down 15%, and it simply cannot hold a rally.
Technically, Bank of America shares showed hopes of a breakout but have so far failed at sustaining it. It rallied with the markets in general, but it had no extra upside that is specific to its own future expectations.
The Federal Reserve’s reluctance to hike rates is one of the many hindrances that mega-banks face in our current environment. The Fed continues to stifle banks’ bottom line with their easy rate programs. Bank of America can cut expenses to compensate, but that has its limits … so the struggle continues for the near-term.
When the Fed finally raises rates again, markets in general should fall. I expect the financials to also fall after an initial temporary pop. I still favor the path lower for financials in 2016.
I don’t like shorting stocks outright, so instead, I will use the options markets so cautiously short BAC. The options markets allow me to define my risk and time frame during which I want the risk to exist.
BAC Stock Options
Trade #1: Buy the Jun $14 put. This is a bearish trade for which I pay 44 cents per contract (also my max potential lost). I need BAC stock to fall fast by mid-June. Usually, I like to lower my entry cost by selling risk to generate income. In this case, I may wait before I deploy a second part to this trade. If so, I will hold the long put position naked with a tight stop.
Trade #2 (Optional): Sell the Jan $10 put. This is a bullish trade for which I collect 26 cents per contract. This cuts my out-of-pocket expense by more than half. I sell naked puts only if I am willing and able to own BAC stock at $10 per share.
Taking both trades, I would want Bank of America shares to fall, but bounce just above $10 per share. Right now, BAC’s chart shows that $11 should serve as support.
Trade #3 (Variation for smaller dollars at risk): Instead of taking trades 1 and 2, I could simply pull off one bearish trade and buy the Jun $14/$13 debit put spread. This is a bearish trade for which I pay 26 cents per contract. If BAC stock falls past both legs in the next two months, I stand to more than double my money.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
