Call Options Or Put Options On BAC?
Bank of America (BAC) is climbing a wall of worry…
There’s no doubt about it, BAC has had a rocky road to recovery after the 2008 financial crisis. But as you can see, the second largest bank in the US has doubled from $5 to $10 since mid-December.
Is now the time to buy call options on BAC as it soars higher? Or should you buy puts on BAC to profit as the bank falls back to earth?
The bullish case for BAC is pretty straightforward…
Bank of America’s fate is tied to the health of the US economy. That’s why the Fed ‘stress tests’ the bank to see if it can handle a major economic downturn.
The good news is BAC passed the Fed’s recent stress test. A welcome development after BAC failed the test last year… a result which led the Fed to reject the bank’s request to increase their dividend.
Additionally, economic data in the US is strong. And Fed Chairman Bernanke has said he has no plan to hike interest rates or remove any of the economic stimulus.
And don’t forget, the Euro Zone finally has Greece and the sovereign debt problem under control. So the risk of another financial meltdown has been dramatically reduced over the last few months.
What’s more, BAC’s revenue growth is outpacing the industry. Earnings per share growth has trended higher for more than two years. And gross margins have expanded to 75%.
Obviously the improving macroeconomic picture has helped fuel the rebound in BAC’s stock price.
What’s the catch?
There’s a bearish case for BAC as well…
There are still strong headwinds to the global economic recovery. For instance, economic growth in China is slowing, the Euro Zone is teetering on the edge of recession, unemployment in the US is still too high, and sky high oil prices are threatening to choke off consumer spending.
If the global economy struggles, BAC will have a hard time improving profitability. And with an industry trailing net profit margin of just 6.4%, BAC needs to improve profitability.
Plus, the bank’s debt-to-equity ratio of 2.7 is also higher than the industry average. That means management isn’t doing a good job of managing their debt levels.
Don’t ignore the fact that BAC has performed miserably over the last year. The stock is still down 30% from the 52-week high.
And after doubling from $5 to $10, some investors will be taking profits. The selling from investors taking profits could put a lid on any further upside for a while.
Here’s the bottom line…
BAC’s doubled from $5 to $10 because of its improving capital position. In other words, they passed the Fed’s stress test. Now the focus will shift to the bank’s earnings potential.
If you think BAC will continue soaring over next few months, take a look at buying the BAC May 19 2012 $10 Calls for around $0.50.
If you think BAC is ripe for a correction, take a look at buying the BAC May 19 2012 $9 Puts for around $0.33.
Good Investing,
Corey Williams
Category: Call Or Put Options?
