Bank Of America (BAC) took a serious hit in the last 18 months. From the high of $20, it closed at $5.08 on November 29, 2011. Many people kept buying the stock all the way down believing that at those levels it just cannot go any lower. So what can you do now?
Let’s assume that you own 10,000 shares of BAC at an average cost of $12.50. Your base cost is $125,000 and the shares are worth less than $60,000 now. That’s more than a $65,000 loss. Ouch.
There are several things you can do to recover that loss.
- Just continue holding the shares. From the current price of $5.80, you need the stock to more than double to get back to even.
- Buy more shares. Some will say they are extremely undervalued now, others will argue it is throwing good money after bad.
- Write Naked Puts on BAC. That’s not a bad thing to do as long as you understand that by doing this, you are effectively increasing your exposure to the stock. For example, if you sell ten March 2012 $5 puts at $0.44 and the stock closes below $5 by March expiration, you are obligated to buy an additional thousand shares of BAC. Your base cost for those shares will be $4.56 (5-0.44), which is significantly lower than the current price, but your exposure to BAC will be increased. In addition, there are heavy margin requirements for naked puts.
- Write covered calls against the stock. For example, you can sell 100 January 2013 7.50 calls at 0.88. You bring some additional income ($8,800) and if the stock is above $7.50 by January 2013, you will no longer own the stock, but you are still underwater.
There might be a better way. It is called Stock Repair Strategy. The strategy involves buying a 2:1 ratio call spread. Let’s see how it works in the case of BAC. The possible trade is:
- Buy 100 BAC January 2013 7.5 calls.
- Sell 200 BAC January 2013 10.0 calls.
The cost to execute this trade is zero (or very close to zero) and no additional margin is required. You are basically buying a 7.5/10.0 debit call spread and financing it by selling an additional 10.0 call, which is covered by the 100 shares of stock.
If the stock is at $10 exactly by January 2013 expiration:
- Your 10.0 calls expire worthless.
- You sell your 10,000 shares for $100,000.
- You sell your 7.5 calls for $25,000.
Hallelujah! You recovered all your losses.
If the stock is between $7.50 and $10.00, you let the 10 calls expire worthless, sell the 7.5 calls and can repeat the whole procedure again. If the stock is above $10.00, your 10.0 calls are assigned, the stock is called away and you have no stock and no options.
I ignored commissions in all my calculations. Make sure you are using the right broker if you are going to trade options.
The main advantage of this strategy is that no additional capital is required. Of course, like with every strategy, there are some disadvantages. The main disadvantage is that if the stock recovers strongly, you don’t participate in any further gains. You just recovered your losses and that’s it. This is still not a bad thing for many investors sitting on heavy losses.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.