Bank of America Corp (NYSE:BAC) had a bull’s-eye on its back Wednesday as the market started to price in the slim (but existent) chances of a President Donald Trump impeachment … or at least a rocky road to getting policies passed in a timely matter. But the negativity in BAC stock is overdone, and in fact, a long strategy should serve us well.
Like Bank of America, other financial stocks have taken a turn moving lower since the beginning of March. Goldman Sachs Group Inc (NYSE:GS) and JPMorgan Chase & Co. (NYSE:JPM) have both seen declines, although the market was just recently setting all-time highs.
Vince Martin just recently pointed out that BAC stock may be, as he calls it, a “set it and forget it” holding. He says that although the current political environment may not be a stable environment for financial stocks, he believes BofA — due to its size, diversification and less exposure to legal changes than other institutions — makes it a stable choice in the sector.
That wasn’t much help Wednesday, of course.
The market was ruthless overall, with the Dow Jones Industrial Average sliding 1.78%.Will the market make a full recovery and test all-time highs soon again, or will stocks throw in the towel and give what many have been asking for — a pullback? That remains to be seen, but something has changed for the time being, and that’s implied volatility.
Keeping this as simple as I can, implied volatility is how options are priced. The higher the implied volatility, the more expensive options are. Generally, when the market or stocks fall like on Wednesday, implied volatility rises making option prices more expensive. One stock that I noticed a pretty substantial increase in was Bank of America. Earlier in the week, the 30-day implied volatility of BofA’s options was in the 18.5% range. At the time of this writing, it has spiked up to the 26.5% range.
So what does this mean for BAC stock?
If you’re an options trader, it means you can sell the higher premium here. One potential option is selling a vertical credit spread, expecting the stock to not move through a certain area.
How to Trade BAC Stock Here
Taking a look at the chart just below, you can see that since Bank of America closed above the $22 level back on Dec. 6, 2016, shares have not closed below that level.
Although the stock has drifted down and close, the area has acted as support and moved the stock higher again.
The option trade outlined below can take advantage of that potential support, as well as of options that are priced more expensive than they were earlier in the week.
The Trade: Sell the Jun $22 put and buy the Jun $21 put for a credit of 15 cents or more.
The Strategy: The maximum potential profit for this trade is 15 cents if BAC stock is trading at or above $22 at Jun expiration. Both put options would expire worthless. The maximum loss is 85 cents ($1.00 – $0.15). This would occur if Bank of America is trading at or below $21 at June expiration. Breakeven is $21.85 at expiration based on a credit of $0.15.
Naturally, for this spread to succeed, an options trader would prefer for BofA to move higher than lower to lower the premiums. If the stock does move lower, the put premiums may increase. Consider it to be a bearish sign if BAC stock closes below $22.
Options traders like to use delta as a percentage of the option expiring in-the-money (ITM). So in this case, the short option had a delta of 0.28 so it has a 28% chance of expiring ITM and a 72% chance of not. The goal of this trade is to buy back the spread for less money or have the options expire worthless. A 72% chance may be worth the risk.
John Kmiecik is the head options instructor for Market Taker Mentoring, and co-author of the eBook 3 Secrets to Making Money in Any Market. Get your complimentary copy of his option trading eBook here. He can be reached at firstname.lastname@example.org. As of this writing, he did not hold a position in any of the aforementioned securities.