I want to profile Bank of America (BAC) more in-depth, but for now I want to focus on a nice option trade I noticed. I know BAC has its problems, but its book value hovers around $20 per share. Well that seems like an opportunity that I can’t just pass up.
To be perfectly honest this is a play on a broader market rally. I have not looked at the specifics of BAC in a while. So what I am looking for is the chance of the broader market lifting, and maybe BAC getting some of its true value. It does not need to go higher than its book value like other sticks. It is so undervalued according to that metric. Now there are concerns, and one should not assume we are going to $20 blindly.
Banks can take a big writedown for assets worth much less, such as those awful mortgages. However, BAC has returned to profitability. While not generating as much profit for assets as it used to it doing fairly well. Considering its price to book ratio in the past, we are drastically undervalued, and even going to slightly below fair value, would be a massive appreciation from this point. Especially, if they keep posting great profits. That would increase their book value further, and as any BAC follower knows the stock price has barely budged.
So to a certain extent the price to book ratio has declined very slowly lately. It is just because the price has been stuck, but BAC is generating profits. It is not something that should be construed as anything more than a small signal for potential appreciation. The fair value price has stagnated, which is fine. I am not looking for $20.
Just consider some of the risks. Big writedown, further weakness in financial sector, etc. It could potentially change how undervalued this is. I don’t think it matters, though. At least not for the way I want to play BAC for now. For analysis about big banks look here.
Trade BAC with LEAPS
I am looking at January 2013 BAC Calls at $12.50, which went for 0.04 last time the market was open. Obviously, this is the kind of extremely risky play that I love. However at $4 per contract, could get 20 contracts for $80 dollars. Even if we start heading past $10 the premiums on this should rocket as long as we are not too close to expiry. I’d say if we start going up before mid-November they should be a good value. On the small chance we see a robust rally, or moving BAC past $10 makes more institutions pile in we could go in in-the-money. Remember these premiums are scraping the bottom of the barrel. I might even go for some February 2013, or March 2013 ones for $12-13, because I could have more earnings reports. They are still low cost, but higher than the $0.04. Remember, it is priced so low for January because the market does not believe it will get there. I am hoping for BAC’s volatility to go through the roof and it starts racing like a greyhound.
I might grab $160 dollars worth because I take a bit more risk. If this goes anywhere, near the money I could be up 10x. If it goes in the money then the sky is the limit. We saw a rally last October, this time I hope BAC can participate. However, the rally was summer this time so fall could see a correction, but BAC hasn’t moved so it could do its own thing if there is buying pressure.