Bank of America Corp (NYSE:BAC) stock has had quite the run since last November. And coming into its earnings season BAC stock is pushing up against its recent highs. Usually this precludes me from selling puts below these elevated levels. But BAC’s fundamentals are very reasonable. It trades at 15 times earnings and in line with its book price. I am not afraid to commit long and eventually own the shares if price goes against me.
So today I want to sell puts into the earnings uncertainty for income. This is a shorter-term trade that I am not afraid to turn into an investment. After all, BAC is a quality bank and owning it a few percent cheaper than even these already reasonable levels cannot be a massive mistake.
Usually, higher highs that come too fast worry me from a technical perspective. A fast rise in a stock traces out a rising wedge that if broken uncovers weak hands and the selling comes fast. In this case Bank of America stock’s rise is not very alarming because it’s happening behind solid fundamentals.
For years, Wall Street undervalued financial stocks due to the havoc they caused in 2008. Since then, banks have been laden with rules and regulations that hampered them from lending to the max of their ability.
Furthermore, the U.S. is in a rate tightening cycle and on Wall Street the impression is that this will translate in more profits for banks. So with less red tape, a healthy balance sheet and rising rates. Add to this the financial engineering that the banks recently announced after the stress test and BAC is on solid fundamental footing.
Click to Enlarge Technically, it’s not ideal to commit new longs near highs, but I am not buying the stock out right and without any buffer. Instead, I will sell downside premium against support levels to generate income. The trick is to find levels that will hold through the earnings period.
An important assumption using this strategy is finding a level where I am willing and able to temporarily own BAC shares.
BAC Stock Options
The Bet: Sell the BAC stock Oct $22 puts and collect 45 cents per contract to open. Here I have a 85% theoretical chance of keeping my maximum premium for max gains. But if price falls through my strike then I must own the shares and suffer losses below $21.55.
Another way I could accomplish the same goal, but with much less money at risk, is by using spreads instead.
The Alternate Bet: Sell the BAC stock Oct $22/$21 credit put spread where I have about the same odds of winning, but with less money at risk. Yet, the spread could yield 15%. The alternative would be for me to risk $25 per share and with no protection into earnings then hoping BAC stock rallies $3 just to match the yield on the spread.
Selling options is risky so I never risk more than I am willing to lose.
Learn how to generate income from options 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.
