Let Bank of America Corp (BAC) Stock Short Itself for You

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Wall Street tends to trade in memes. Since February 2016, most experts have been certain that banks are headed higher even after this massive rally. So today I want to set a pair trade on Bank of America Corp (NYSE:BAC) stock betting against this bullish meme. My thesis is simple: The rally in financials has been unanimously loved; the fall in BAC stock will likely be just as one-sided.

Let Bank of America Corp (BAC) Stock Short Itself for You

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Just look at the 5%-plus drop in Bank of America on Tuesday.

BofA rallied an astonishing 100% low to high in the past 12 months. Bank bulls priced in the best case scenarios for rate hikes and regulatory changes promised by President Donald Trump. Last week, the Federal Reserve raised rates, but the reaction was opposite of expectations.

BAC stock and other banks fell along with interest rates. Perhaps traders were expecting more hawkishness than we got from Fed Chairwoman Janet Yellen.

There are several cliches that could describe the reason I am shorting Bank of America today, but simply stated, I think bulls overshot to the upside.

Selling BAC short outright leaves me open to unlimited risk — that’s unacceptable in an equity market run by animal spirits. Luckily, options offer a relatively safe alternative.

How to Trade BAC Stock Here

The bet: Buy the BAC May $23 put for 81 cents per share. This is a bearish trade that would benefit from falling prices in BofA. Time is my enemy, and my investment would be at risk if price rises or if time passes and the stock stays above my strike.

Earlier, I mentioned that this would be a pair trade. So, before you send out for my arrest for even thinking of shorting a financial stock outright, in my second tranche I will go long BAC.

Just as bulls overshoot to the upside, bears will sell BAC stock too low to the downside. Somewhere in the middle lies the truth of fair value for BofA. So to hedge my bet, I will lower my out-of-pocket risk by selling premium against the illogical downside scenario.

The bank: Sell the BAC Dec $20 put naked. This is a bullish trade for which I collect 87 cents per contract. I am committing to owning Bank of America stock for $20 per share if it falls below it.

Taking both trades would set me short BAC stock for free.

This is a thread the needle pair trade that leverages the value of BAC against its short term price. I need BAC to be below $23 per share by May 19, but stay above $20 through December.

Learn options as easy as 1-2-3 here. 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. You can follow him on Twitter at @racernic and stocktwits at @racernic.

Nicolas Chahine is the managing director of SellSpreads.com.


Article printed from InvestorPlace Media, https://investorplace.com/2017/03/let-bank-of-america-corp-bac-stock-short-itself-for-you/.

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