Bank of America Corp (NYSE:BAC) remains stuck in a six-month trading range that is frustrating bears and bulls alike. But as long as no side is able to win this tug of war, you and I can profit by selling premium in BAC stock.
Wall Street bought the financial stocks behind the idea of a Trump rally. President Donald Trump vowed to unshackle banks by eliminating much of the red tape. Also, the U.S. Federal Reserve is in a tightening cycle, and higher rates should translate into bigger profits for banks.
While Trump is delivering on his promises, there is some recent concern that Janet Yellen has changed her bias. She now sounds committed to raising rates even if the economic data doesn’t clearly show improvement. This new bias could drive Trump to replace her next January. If that happens, bank stocks could suffer.
Another threat to BAC stock comes from the U.S. bond market. See, interest rates and bonds are inversely related; so far, bonds are defying all logic and holding strong at six-month highs. And higher bond prices should weigh down on financials, including BofA.
Experts called the bond market in a bubble for years and have perpetually predicted its bursting. No such event has occurred yet. Bank of America has held up well despite this.
Fundamentally, BofA is about as strong a bank as you get. It trades at just 10 times forward earnings expectations and less than book. Analysts’ expectations aren’t too lofty, either, with their ratings spread evenly across the top three ratings tiers.
Click to Enlarge Technically speaking, BAC stock is stalled once more near $24 per share. It’s not all bad news, though, as shares have returned to a consolidation zone that has held since last December. Thus, any dips into the area are likely to be bought for as long as the macro thesis for banks remains in effect.
The dips also elevate the premiums that I could earn from selling puts and therein lies the opportunity.
When markets fear more downside, I like to sell risk into them for income. But the trick is to chose the right stock and the proven support levels, otherwise I would open myself to owning shares in a falling stock.
Here’s what to do next.
How to Trade BAC Stock
The bet: Sell the Dec $20 puts for 60 cents per contract. This is a bullish trade where we have a 85% theoretical chance of retaining my maximum gains. But if BofA’s price falls below our strike, I have to own the shares and accrue losses below $19.40.
Usually I like to sell opposing risk for balance. But in this case, and with a 13% buffer from current price, I am confident that I will be able to manage my risk against short-price gyrations. And the worst-case scenario of owning Bank of America stock is totally acceptable.
Nevertheless, I realize that some investors might prefer to limit the risk. So instead of selling naked puts, we could turn this into a credit spread.
The alternative bet: Sell the Dec $20/$19 credit put spread where we have about the same chances of success, but with limited risk. If successful, the spread still yields 20%.
The alternative to selling downside risk is risking $23 here on shares of BAC stock outright, and with no room for error. Then we’d have to hope Bank of America could rally 20% to match the performance of the spread.
Selling options is risky business, so never risk more than you’re willing and able 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.
