Bank of America BAC may look as though it is headed higher from a late-August bottom, but one options trader isn't sure if the shares will continue moving higher or will snap back lower. They do appear to expect a dramatic move, however, and seem to have expressed that thesis by scooping up longer-term long straddles.
Shortly after 1:00 p.m. Eastern Time yesterday, a block of 2,000 May 14 calls traded at the same time as 2,000 May 14 puts and the transactions were indeed flagged as a spread. The calls changed hands for $1.55 a piece (the ask price at the time) and the puts traded in the middle of the market for $1.72 per contract.
It appears that an investor bought 2,000 of these long straddles for $3.27 each. At the time of the transaction, the stock was trading at $13.82. This means the price of the straddle is almost 24% of strike. In other words, the long straddle buyer is expecting BAC to move roughly 24% – higher or lower away from the strike price– between now and when the options expire next May (240 days from now).
A 24% move away from the 14 strike would bring BAC to $17.27, while a 24% drop takes the stock to $10.73. These are the breakeven levels for this straddle trade. At expiration, above $17.27, gains are theoretically unlimited. Below $10.73, gains are significant but ultimately capped at the zero level.
If BAC were to be trading right at 14 when the options expire, the trader loses his entire $3.27 investment ($654,000 for the 2,000-lot). To visualize this straddle's risk and reward at expiration, I've used a profit/loss calculator courtesy of my virtual trading account (sign up for your own).
In addition to the exposure a long straddle gives the holder to stock price moves, this transaction taking place in the May 2011 series also gives the long holder a long Vega position in BAC. Vega is the Greek term for exposure to changes in implied volatility. Should implied volatility rise in these May options, this trade could be exited prior to expiration for a profit. The flip side, however, is if implied levels fall, the trade will be marked against the long straddle holder. The PNL calculator tool also allows OptionsHouse traders to simulate any volatility scenarios to visualize the theoretical profitability of many spreads.
In a separate transaction, Bank of America LEAPS options were also busy Tuesday as an investor likely purchased a long-term bear put spread. In mid-morning trading, it appeared as though 15,000 January 2012 12.50 puts were sold for $1.83 apiece while 15,000 January 2012 15 puts were simultaneously purchased for $3.10 apiece. The net debit for this spread was $1.27, which is the most the spread trader can lose at expiration if BAC is trading above the 15 strike.
The maximum gain for this spread, meanwhile, is $1.23, or the difference in strike prices minus the debit paid. If BAC is trading below the short strike (12.50) at expiration in about 16 months, the maximum profit is achieved. Breakeven for this bear put spread is $13.73 at expiration, so the spread will be profitable as long as BAC closes below this level.
Remember with this spread (and the straddle detailed above) that the majority of options positions are not held through expiration. Investors often opt to take profits (or losses) off the table before expiration Friday … sometimes well before.
Photo Credit: lewisha1990
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