No one doubts the Oracle of Omaha’s track record. But a less pleasant narrative for Bank of America Corp (NYSE:BAC) off and on the price chart suggests other investors purchase a bearishly targeted butterfly spread in lieu of buying BAC stock today for a greater margin of safety. Let me explain.
Off the BAC stock chart — and as recent as early May — Bank of America investors were brimming with renewed optimism. Forthcoming and beneficial rate hikes, as well as corporate tax breaks and banking industry deregulation under the new administration, were all but written in stone.
Unfortunately, the BAC narrative has done a 180. Investors like Warren Buffett are now coping with impeachment chatter and the tied-at-the-hip realization that favorable legislative changes for the banker could be incredibly slow or even nonexistent.
BAC investors are also dealing with a fresh one-two punch. This past week Bank of America warned of weaker Q2 revenues at a conference. And now, Friday’s weaker-than-expected jobs report has tilted the rate environment against BAC stock with a more difficult, flattening yield curve.
Bottom-line, if you want to invest alongside the Oracle of Omaha in BAC stock right now, that’s your choice. And as alluded too, Buffett has proven himself to be ‘head and shoulders’ above the rest.
But if you prefer respecting the BAC price chart and options market to obtain a stronger margin of safety, the combination suggests positioning a bit more creatively and cautiously in Bank of America.
BAC Stock Daily Chart
Charts don’t lie, but technical about faces happen often enough and sometimes it doesn’t take long to acknowledge that type situation. I’m reminded of this potential in BAC stock — and it doesn’t look good for today’s investors.
It was less than a handful of weeks back when shares of Bank of America were trying to put the final technical touches on a bullish profile. BAC stock had already established a correction of about 14% and confirmed a low with a small double bottom. BofA then went on to rally above the 50-day simple moving average.
Overall, the message of the chart, outside of an overbought stochastic condition, appeared favorable for BAC stock and its investors. Nevertheless, an abrupt and bearish price gap in mid-May followed by a failed attempt to clear the 50-SMA, has changed the technical picture.
In our view, the price action has developed into the right shoulder of a slightly flawed, but bearish head and shoulders topping pattern. Worse, it appears the neckline has been penetrated and could be warning of a more meaningful correction in BAC stock.
BAC Stock Bearish Butterfly
For investors who ultimately wish to buy BAC stock, given the tenuous technical picture and after reviewing Bank of America’s options, I like the idea of a two-pronged approach for positioning.
The first part of a strategy to buy BAC with greater care or a stronger margin of safety involves buying a bearishly targeted July $22/$21/$20 put butterfly for up to 15 cents with shares trading at $22.45.
If it turns out BAC stock is able to diffuse the bearish technical picture without moving lower, such as reclaiming the 50-day simple moving average in the coming weeks, the investor can buy shares with greater confidence a bullish trend is emerging. That forfeited spread value seems like a small price to pay, don’t you agree?
On the downside and if the bearish outlook pans out, the butterfly has an expiration profit range from $20.15 to $21.85. If the investor is able to buy BAC stock in this below-market price zone, the actual cost basis could be even more substantial after factoring in any potential profits from the spread.
Lastly, if the situation in BAC stock turns really bloody and the investor is buying when others are truly fearful, the spread cost of 15 cents may be forfeited, but purchasing shares at a discount of 10% or more and below $20 a share is a margin of safety that even Buffett could appreciate.
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.
