Bank of America Corp (NYSE:BAC) reported earnings on Tuesday morning that beat on both the top and bottom lines. Revenues of $22.2 billion were better than expectations for $21.6 billion, while earnings of 41 cents per share also exceeded the consensus mark of 36 cents. But BAC stock behaved … well, weirdly.
While BofA initially rallied on the earnings news, that ebullience was soon dampened by the news of a big profit miss by Goldman Sachs Group Inc (NYSE:GS), along with a deeper drill-down into the BAC earnings. Bank of America closed down 10 cents on the day, and I expect the stock to languish over the coming weeks.
And that’s OK.
On the surface, earnings were impressive, with a nice pop to net interest margins thanks to the Federal Reserve interest-rate hike. A closer looks highlights some concerns, however. One is the drop in loan loss reserves, which effectively is a huge piggy bank for the banks. By lowering their loss reserves, they can effectively goose up earnings. InvestorPlace Market Strategist Anthony Mirhaydari delves neatly into this in his BAC article.
Another worry is that most of the earnings beat (outside of lower loan loss reserves) was attributable to trading revenues, especially on the fixed income side. As we know, trading revenues can be fickle. Core businesses, such as mortgage origination and lending, were less than stellar.
Click to Enlarge From a technical perspective, BAC stock did hold the critical support level at $22.30. It also bounced nicely off the 14-day Relative Strength Index oversold reading for the second time, meaning Bank of America is still slightly positive (up 2.76%) year to date.
Much of the initial euphoria that catapulted Bank of America 50% higher following Donald Trump’s election victory has noticeably waned. Hopes for Dodd-Frank reform and a friendlier regulatory environment have diminished greatly, especially following the Obamacare repeal defeat. While the Federal Reserve has raised rates once this year (a positive for NIM), the likelihood for three more rate increases in 2017 is just jawboning, especially in light of slower economic growth. The Atlanta Fed is now looking for just 0.5% expansion in Q1 GDP.
So with many of the tailwinds for BAC stock now diminished, I expect BofA to chop around the $22.30 support area for the next few months.
To position for a period of consolidation, a combination put sale and call spread sale makes sense.
Our Trade on BAC Stock
Sell the BAC July $22 puts at 90 cents and sell the BAC July $24/$26 call spread for 45 cents.
The total credit received is $135 per combo. Ideally, Bank of America closes between $22 and $24 on July expiration to keep the $135 initial credit.
Upside risk is limited to $65 if the stock is above $24 at July expiry. If BofA is below $22, you end up long 100 shares of BAC stock for each combo sold, with a effective cost of $20.65.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
