Email – #477
Today we are going to enter into a “strangle” trade. In a strangle we buy both a call option (a bet that shares are going higher) and a put option (a bet that the shares are going lower). The strike prices are not at the money, but out of the money.
I believe using a strangle is the best option right now because I’m expecting a major move in one direction. That move must be large enough to offset the losses from one side of the trade. But there’s more…
You need volatility, and nowhere is that more prevalent than in the financial sector. Second, you need a company that has the potential to hit it out of the park, if it does not fail first. And finally, you need a vehicle that can be traded.
For example if Bank of America goes lower, the put option will increase in price… and if it goes lower because of a general market correction, there is a strong chance it will rebound later as well. This gives us the opportunity to then lock in profits on one side of the trade, and then make more money if the direction changes.
This can’t be done using short-term options because there quite simply isn’t enough time. But it can be done using LEAPS because we will have almost 19 months for this trade to play out.
I’m choosing Bank of America (NYSE: BAC) because it has tremendous leverage to the economy, both up and down. With major market share in the mortgage market (through Countrywide) it will either react well or poorly to a housing recovery. With major share in Investment Banking (through Merrill Lynch), it will do well if the market recovers and deal making resumes. And, with the largest consumer banking operations in the US, it is a play on the resumption of spending by consumers… or a continued decline.
As you can see, this is a good candidate to make money regardless of direction. And the only way we can lose is if the shares stay range bound and move nowhere, which is a risk I’m willing to take.
Here’s what you need to do:
* Buy the Bank of America January 2011 $7.50 PUT LEAPS (VBA MQ) at current levels of $1.95
* On the call side, buy the Bank of America January 2011 $15 CALL LEAPS (VBA AC) currently trading at $2.65
Our bias is to the upside in this trade as BAC has almost completed a massive capital raise which should allow it to absorb further losses. Any, major moves in consumer spending or sentiment in the coming months will play out well for the financial sector.
BAC has the ability to generate significant earnings through its operations and through claw backs of loss provisions if its portfolio of loans performs better than expected. It is not out of the realm of possibility for the shares to move from the current $10.93 level to more than $20 to $25 within a year.
Of course, they could easily go in the other direction if the economy does not respond to the massive economic stimulus in the pipeline.
Karim
Current Portfolio:
Company / Option: Bank of America
Option Symbol: New
Current Price: New
Comments: See instructions above
Company / Option: US Steel Jan. 2011 $120 calls
Option Symbol: OUS AD
Current Price: $0.45
Comments: Hold.
Company / Option: Yamana Gold – bull spread
Jan. 2011 $11 call (bought)
Dec. 2011 $12.50 call (sold)
Option Symbol: VPP AB
Option Symbol: VPP AV
Current Price: $3.60
Current Price: $2.45
Comments: Hold
Company / Option: Freeport Copper & Gold – bull spread
Jan. 2011 $30 call (bought)
Jan. 2011 $50 call (sold)
Option Symbol: OBQ AF
Option Symbol: OBQ AJ
Current Price: $26.50
Current Price: $15.90
Comments: Hold
Company / Option: Akamai – bull spread
Jan. 2011 $15 call (bought)
Dec. 2010 $20 call (sold)
Option Symbol: OMU AC
Option Symbol: OMU AD
Current Price: $9.30
Current Price: $6.60
Comments: Hold
Company / Option: Petrobras – bull spread
Jan. 2011 $30 call (bought)
Dec. 2011 $45 call (sold)
Option Symbol: VDW AF
Option Symbol: VDW AI
Current Price: $16.50
Current Price: $7.70
Comments: Hold
Company / Option: Motorola – bull spread
Jan. 2010 $7.50 call (bought)
Dec. 2010 $10.00 call (sold)
Option Symbol: WMA AU
Option Symbol: WMA AB
Current Price: $0.78
Current Price: $0.25
Comments: Hold