Bank of America is scheduled to report earnings this coming Wednesday, Jan 20. I am going to leave much of the fundamental picture out of this discussion and instead just reference my earlier post regarding JP Morgan's earnings. Overall I expect mediocre to slightly bearish earnings at best.
From technical standpoint, BAC has nicely held $15 support line since late July 2009 with the exception of late Oct sell-off for a few days. Also, much of potentially negative reaction (if there is going to be one) may already be priced into the stock now as JPM earnings is already behind us. Therefore, the best trade here is sideways reaction in my opinion. Bank stocks cannot continue to rally with shrinking balance sheet and unemployment at 10%.
I like the following Double Diagonal Swap:
- Buy to open May $18 strike calls
- Buy to open May $15 strike puts
- Sell to open Feb $17 strike calls
- Sell to open Feb $16 strike puts
The whole trade can be done for a net debit of $0.53 based on Friday's closing prices. Two things I like about this trade:
1. Currently, at-the-money straddle is selling for $1.44, which means market participants expect about 8-9% move in the stock by Feb expiration. However, as the attached P&L chart shows, the trade would remain profitable for up to 11% move on the upside. On the downside, the break even is $15.25 which is close to 6-month support line.
2. Since the long options bought are far out in May and VIX is at 2-year low, any return of fear in the market should see the Implied Volatility rise benefiting the long option. Lastly, Feb options could be rolled over to Mar and then to Apr based on the risk preference towards the end of Feb expiration.
Always remember that you must know the reasons for getting into a trade and you must understand the reason for staying in it longer than desired time frame. I will return back to this trade after BAC reports to re-evaluate those reasons.
