My last attempt at shorting Bank of America Corp (NYSE:BAC) was … well, it was unsuccessful. Luckily, it was a lotto style put spread in BAC stock where I risked just a few cents per contract.
Click to Enlarge Since the election, financials have been unrelenting riding a huge rally in interest rates. The chart of the ProShares UltraShort Lehman 20+ Yr(ETF) (NYSEARCA:TBT) — a short bond exchange-traded fund — is another way to show the steepness of the bank rally. Technically, the TBT also warned of the breakout of financials.
From here, there should be resistance at a longer-term pivot level.
The Financial Select Sector SPDR Fund (NYSEARCA:XLF) still shows technical promise, but at a certain point, financials need a breather. Goldman Sachs Group Inc (NYSE:GS) rising 25% in 25 bars is not normal. Also recently, Wells Fargo & Co (NYSE:WFC) noted challenges arising from the sudden higher-rate situation. So there will be a point of diminishing returns for banks from higher rates.
Today, I will set a pair trade on BAC to try to capture downside potential if it comes. I’m not looking to profit off a crash in financials, but it’s not unreasonable to expect banks to give a little back after such a huge rally.
How to Trade BAC Stock Here
Trade #1 – The bet: Buy the BAC Jan $20/$21 debit put spread for 20 cents per contract. I need Bank of America stock to fall through both legs by January expiration for a chance to quadruple my money. Time is not my friend, so the sooner this happens, the better.
Usually, I like to balance my trades. In this case, the hedge could actually be the bank. Since BAC is rallying with the rising rates, I will sell bullish premium in TBT to offset the risk to my first trade.
I chose the TBT because it rises in tandem with interest rates.
Trade #2 – The hedge: Sell the TBT Jan $38/$37 credit put spread for 21 cents per contract. If successful, this would yield 25% on money risked.
I usually don’t like selling bullish premium after such a rally. But in this case, we have the promise that the Federal Reserve will resume raising rates starting this December. So there should not be downside pressure on rates in general.
Taking both trades makes the pair trade free — it literally costs nothing to enter the trade. But we do open risk from the potential of a TBT failure. So I could delay entry into the TBT for a couple of days.
Once both trades are open, I want Bank of America stock to fall below $21 per share by January. But I also need the TLT to stay above $38 per share during the same time.
This is a thread-the-needle type trade but should fit the unique current environment. If nothing happens, I lose nothing since I would have entered the trade for free. Any premium I collect from selling the BAC put spread would be pure profit if TBT stays above $38 per share.
I am not obliged to hold these trades through expiration. I can close either at any time for partial gains or losses.
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.