We’re starting to feel like we sound like a broken record. We keep talking about tariff threats, volatility and the erratic nature of President Trump’s tweets.
Last week, the trade war escalated as President Trump responded to retaliatory tariffs from Beijing. He said he would raise the tariffs on China by another 5%, and he even said he could declare the trade war a national emergency.
China is responding by continuing to manipulate its currency, which could have an adverse affect on the market. It doesn’t look like the narrative will change anytime soon.
We recently accepted shares of Bank of America (NYSE:BAC) common stock when our BAC August 16th $30 Put Write expired in the money, but luckily for us, the impact of all this news has given us a chance to collect income on one of our favorite banking stocks. Though perhaps we should say “as we expected,” rather than “luckily.”
We are expecting income in these trying times because we’re making smart choices. We bought our last put write knowing that we may be put the shares, and we happily accepted them because BAC is a great stock to sell covered calls on.
Bearish Pressure from the Yield Curve
BAC and other banks are experiencing some bearish pressure from an inverting yield curve. You see, one of the ways BAC generates revenue is by borrowing money from depositors at shorter-term interest rates and then lending that money to borrowers at longer-term interest rates. The difference between the amount banks pay for shorter-term interest rates and charge for longer-term interest rates is called net interest margin.
During normal economic circumstances, shorter-term interest rates are lower than longer-term interest rates and the net interest margin is positive. However, during abnormal economic times, like we’re experiencing right now, that relationship reverses. Shorter-term interest rates become higher than longer-term interest rates.
This phenomenon is referred to as an inverted yield curve. When the yield curve is inverted, it is extremely difficult for banks to generate as much revenue by lending money because their net interest margins are so compressed.
A Well-Defined Trading Range
The bearish pressure from the inverted yield curve gives us a chance to sell covered calls on BAC without fear of having the stock called away. If we look at a chart for the stock, we can get a better idea of what a good strike price would be.
Looking at the chart below, we can see BAC is consolidating above support at around $26.50. We expect the yield curve to remain inverted for a while, which means BAC is going to have a difficult time increasing its revenue from net interest margin.
This slowdown in revenue growth should keep BAC toward the bottom of the longer-term channel. The stock has been between support at around $26.50 and resistance at $31 since early 2019.
If you look at the chart, you’ll also see that BAC is below both its 50- and 200 day moving averages. Right now, its 200-day moving average is at just above $28. It acted as resistance back in mid-August, and it may do so again if BAC attempts to rally. If we want to avoid having our stock called away from us so we can sell another call when this trade expires, $28 may be a good strike price.
To find out which BAC covered calls we’re selling—and to get access to our full portfolio of income-generating trades—sign up for a risk-free trial of Strategic Trader today.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of Strategic Trader.