Bank of America (BAC) Option Strategies for Bulls and Bears

Bank of America BAC has seen mixed reports of late, including rumors of a WikiLeaks exposure. The shares have gained more than 5.5% from Wednesday's close but are still off more than 15% year to date. Has the stock truly begun to recover or will this be a mere hiccup as part of a longer-term downtrend? And if stock traders want to explore strategic alternatives using options, what can they consider?

For BAC bulls and bears, we have outlined two option strategies below. These write-ups are educational in nature and should not be regarded as buy or sell recommendations. All prices are as of Tuesday morning, when BAC shares were trading at $12.62, up eight cents on the day.

Bullish Option Strategy: Stock Replacement Strategy

Investors with a bullish outlook on BAC could go long short-term calls as an alternative to buying the stock outright. For a premium of $1.83 per contract ($183 per lot), investors can buy the February 11-strike call, which provides the right (but not the obligation) to buy 100 shares of BAC stock for $11 per share.

This long-call purchase compares to simply buying 100 shares of BAC for a total cost of $1,262. The call is only 21 cents over parity at the time of execution (breakeven minus the stock price). Note that long call holders do not collect dividends, and BAC is scheduled to pay a small (one cent per share) cash dividend on December 24.

At expiration, if BAC is trading above the breakeven price of $12.83, gains in the option are potentially unlimited. Losses, however, are limited to the $1.83 paid for the contract. Losses peak below the 11 strike in the long call while the long stock holder would have unlimited downside exposure to the zero mark.

Delta is currently 80 for this in-the-money call. All other factors being equal, the call should increase in value by 80 cents for every $1 that BAC gains. Conversely, the call stands to lose 80 cents for every $1 that BAC falls.

The chart below was built using the profit/loss calculator, which lets you change inputs such as volatility percentage change, days to expire, and stock and option pricing. Open a virtual trading account to explore this and other tools.

Profit and loss of Bank of America (BAC) long call

Bearish Option Strategy: Synthetic Short Stock

Think the stock is damaged goods and will ultimately continue its downtrend? Consider a risk reversal, also known as a synthetic short stock. This strategy combines a long put that is more than offset through the sale of a short call (both options are typically out-of-the-money in this strategy).

By buying the February 11 puts and simultaneously selling the February 13 calls, traders collect a net credit of 30 cents. They'll keep this credit as a modest profit at expiration if BAC shares are trading in between the 11 and 13 strikes.

Below the 11 strike, gains begin to accelerate as the stock declines. If BAC were to drop all the way to zero, the trader could make as much as $11.30 (the long put strike plus the initial credit).

In the other direction, above breakeven of $13.30 (the short strike plus the credit collected, losses are unlimited should BAC continue to move higher. Of course, an investor can opt to close out of this trade at any time, even before expiration.

Profit and loss of Bank of America (BAC) synthetic short stock

Photo Credit: lewisha1990

The above information is provided by OptionsHouse, LLC (“OptionsHouse”) for informational and educational purposes only and is not intended as trading or investment advice or a recommendation that any particular security, transaction, or investment strategy is suitable for any specific person. You are solely responsible for your investment decisions. Commentary and opinions expressed are those of the author/speaker and not necessarily of OptionsHouse. Neither OptionsHouse nor any of its employees, officers, shareholders or affiliated companies guarantee the accuracy of or endorse the views or opinions of guest speakers or commentators. Projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature and are not guarantees of future results. Any examples used that discuss trading profits or losses may not take into account trading commissions or fees.

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