Financial stocks have been humming over the past week or so, with the S&P 500 Financials rotating from one of the market’s weakest sectors in the week ending November 24 to the top of the five-day momentum heap as of yesterday.
And options traders have been busy in banks the past few days—not surprising, given the attention financial shares have gotten recently because of their potential to benefit from tax reform.
One trader target: Bank of America (BAC), which saw a lot of action on Tuesday and Wednesday, including some prints of 18,000 January $30 calls and puts. BAC is still a long way from its 2007 high around $55, but its recent rally to near $30 has it at its highest level since late 2008.
It’s fair to ask whether the excitement over tax cuts has already been priced into BAC and other banking stocks (that whole “buy the rumor, sell the news” thing). But there may be more going on than taxes. Bank of America has beaten earnings estimates the past four quarters, most recently on October 13, and the company just got an upgrade from Moody’s, which cited the bank’s improving profitability and commitment to a more conservative risk profile.1 That doesn’t rule out an additional retracement, but it may help keep a bid under BAC prices after the tax story fades.
Traders looking for some upside exposure with limited risk can consider using options rather than an outright stock play. Take for instance a bull call spread—a long at-the-money call paired with a short, higher-strike call with the same expiration. The long call profits from an up move in the stock, while the premium collected from selling the second option reduces the cost of the long exposure. But the short option also limits the possible profit, which maxes out at the difference between the two strikes minus the cost of the spread.
The chart above shows the profit/loss profile for a sample bull call spread consisting of a long BAC January $29 call and a short BAC January $31 call created with the E*TRADE Options Analyzer (login required).
Short-term trades and long-term investments have different purposes and employ different strategies. Veterans of the trade will tell you that the more flexibility you have to react to developments on the ground, the better.
1 Zacks.com. BofA's Long-Term Ratings Upgraded by Moody's, Outlook Stable. 12/7/17.