Up until recently, experts were touting the upside potential of financials. I’ve been against that notion. I’ve correctly argued that traders should not chase the Financial Select Sector SPDR Fund (NYSEARCA:XLF) too far. Financials were in a lose-lose situation, especially Bank of America Corp (NYSEARCA:BAC).
BAC stock is down 22% year-to-date, while the XLF is down 6%. Fundamentally, BAC comes with legal baggage in a low-rate environment that is already harsh for financials in general. Technically, Bank of America shares never recovered from the 2008 financial disaster.
A long-term chart shows that it has reverted to trading in a really old price range.
Shorter-term, I see important levels that could bring about trade-able moves within that range. Depending on one’s thesis, the options markets provide hundreds of setups for potential profits.
Today, I want to share my neutral trade setup for BAC shares that fits within my overall global somewhat bearish thesis for 2016.
Since I can argue both bullish and bearish outcomes for banks in the coming month, I chose a neutral trade. For me to be successful, I need to pick a range within which BAC stock trades for the rest of the year. The trade offers me a high potential yield with a relatively high theoretical chance of success.
Trade #1 – The bullish side: Sell the BAC Jan $10/$9 credit put spread for 12 cents. This is my max profit and offers me a potential 13% yield on risk. My theoretical chance of success is about 85%. Max loss is 88 cents per contract. For me to be successful here, I need BAC stock to stay above $10 per share through 2016.
Trade #2 – The bearish side: Sell the BAC Jan $16/$17 credit call spread for 12 cents. This is my max profit and offers me a potential 13% yield on risk. My theoretical chance of success is about 80%. Max loss is 88 cents per contract. For me to be successful here, I need BAC stock to stay below $16 per share through 2016.
Taking both trades would give me a sold iron condor, which is a self-hedged trade. Taking both sides also means that I collect a total of 24 cents per contract. This reduces my dollars at risk since I can only lose on one side or the other. Still, the maximum losses if I’m incorrect are considerable, so don’t make this trade on a lark.
My potential yield if successful climbs to 31%.
To win overall with the sold iron condor, I would simply need BAC stock to stay within the upside buffer of +22% and the downside buffer of -23% from current prices.
In other words, Bank of America shares can rally or fall about 23%, and I can still claim full profit.
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.
