Last week’s market swoon did a lot of damage to financial stocks like Bank of America (NYSE:BAC), and with yesterday’s down gap, Bank of America stock is testing a key support threshold. With the shares at a crossroads, now seems like the perfect time to update my outlook and build a trade.
Let’s begin with a look at the Financial Sector SPDR (NYSEARCA:XLF). Analyzing a stock’s sector provides context for our analysis. Virtually all companies exhibit a positive correlation with their sector.
If XLF is booming, then that provides a tailwind for BAC. Alternatively, if it’s rolling over, then that offers a headwind.
Financial Sector Movements
Financials took flight on May 26 on an upswing that increased the momentum of its uptrend. The rally was a widespread affair that saw small-caps everywhere finally play catch-up with a rally that had previously been led by large-cap tech giants.
It signaled a broadening of the recovery. After tagging the descending 200-day moving average, sellers finally struck, and XLF suffered a sharp drop. The decline was so severe that it essentially retraced the entire upswing.
What was particularly worrisome was last Thursday’s massive distribution candle in the wake of a Fed meeting that suggested zero interest rates will be here until 2022.
The market didn’t like the grim forecast, and banks really didn’t like it. XLF breached its 20-day moving average, but remains above the 50-day. So far this morning’s gap lower was quickly bought. If we can hold above the 50-day, I think the bullish thesis remains intact. If XLF falls below it, however, I’d be a seller.
Bank of America Stock Charts
Bank of America’s price chart finds itself in a similar position as XLF.
Before diving into the daily time frame, let’s begin with the weekly chart to acclimate ourselves to the big picture. Though messy, the weekly trend has turned higher since the March low.
The rally sparked in late-May carried BAC to a post-crash high and created a higher pivot high for the nascent uptrend. Interestingly, sellers emerged right at the descending 50-week moving average. This will be a pivotal level to watch on the next ascent.
Last week’s candle was a doozy, but fortunately, BAC is still making a higher swing low to keep the weekly uptrend intact.
The pullback did push the daily time frame below the 20-day moving average, but so far, bulls are defending the 50-day moving average. Thursday’s gap lower was quickly bought, and Bank of America stock is at the high of the day at the time of this writing.
I like using $23.50 as the line in the sand for determining the short-term bias. As long as we’re above this support level, I like betting with bulls. Push below it, however, and BAC goes to the dog house.
The speed and depth of last week’s retreat have me favoring mildly bullish plays over aggressive ones. Fortunately, implied volatility is high enough at the 36th percentile to make option selling strategies interesting. If you think BAC can continue to hold support and want to deploy a neutral to bullish position, then naked puts are worth a shot.
The Bottom Line
The Trade: Sell the July $22 puts for around 63 cents.
The initial margin required is only around $220, so the potential profit of $63 works out to a tasty 29% return on investment. The options board is pegging your odds of success around 78%.
If you’re a willing buyer of the stock, then you could let the trade ride and take assignment if BAC falls below $22. Otherwise, you can stop out on a push below $22 to minimize the loss.
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