To be sure, the narrative has been “yuge” for Bank of America Corp (NYSE:BAC). In the here and now though, overly optimistic discounting in BAC stock means investors might explore a partially hedged, modified collar entering 2017. Let me explain.
It’s been an explosive several weeks for BAC stock and the country’s second largest bank since Donald Trump won the presidential election and Republicans took control of Congress.
Enviable, or maybe terrifying, support for making our too-big-to-fail institutions even larger and more powerful could be offering the keys to the castle, or at least Capitol Hill to Bank of America and its constituents within the Financial Select Sector SPDR Fund (NYSEARCA:XLF).
Considering pledged corporate tax breaks, financial deregulation and Dodd-Frank legislation reform, growing conviction of a rising and interest-rate friendly environment for banks (and with Wall Street crony capitalism at its best), let’s just say Christmas came early this year for BAC stock.
This strategist has some concerns, though. With nearly a month until the Trump administration takes office, and considering an overly bullish narrative prone to hitting a snag and shares of BAC overbought near-term, it’s time to be more cautious.
BAC Stock Weekly Chart
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From a rapid gap-based, two-session breakout through BAC’s July high of $18.48 on Nov. 11, shares of Bank of America have raced up 33% and remained glued to an optimistically widened Bollinger band.
Our expectation is signs of minor exhaustion will give way to a minor corrective move. This could lead to BAC stock pushing toward $20 to $21 before more supportive buying is seen. A move into this price zone represents a decline of 10% to 15% from recent highs and incorporates a Fibonacci retracement of 38% from BAC’s late September low of $14.81.
BAC Stock Modified Collar
Given the supportive dynamics that appear to be working toward making BAC stock great again, but with shares overbought near term, a modified collar on Bank of America looks attractive.
Reviewing BAC’s options, selling the Jan. 20 $23.50 call and purchasing the Jan. 20 $22/$20.50 put spread is priced for even money with shares of BAC stock at $22.60.
For the combo price of $22.60, this bullish investor maintains roughly 4% of upside over the next few weeks until the sold call caps his or her profit at $23.50. That’s unadjusted and on an expiration basis. If bullish conditions allow, the return can be potentially increased by rolling the options.
If BAC stock does end up trading lower in the near term, the trader has a partial hedge in place with the $22/$20.50 bear put spread.
As the spread protection effectively cost no money to establish, there is theoretical protection of up to $1.50 if shares were to shed 9% or $2.10 from today’s $22.60. Thus, the trader would be out 60 cents or less than 30% of his or her long BAC stock counterpart.
It should be appreciated, the ideal and maximum risk offset from using a vertical as a BAC stock hedge isn’t altogether realistic. At the end of the day, both the time and price would have to be perfectly aligned. Nonetheless, this modified collar trumps the alternative reality in our estimation.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.
