I was talking to a friend who asked me about Bank of America (BAC), which he purchased for around $20. Now, of course, the stock trades at around $7 per share.
My advice? Consider using options to reduce the risk of holding the shares.
Let's say I owned 1,000 shares that cost me $20,000. It's going to be a long time, if ever, that the stock ever sees double digits, let alone a double digit that begins a "2."
But even though the shares are only worth about $7,000, that's still money one can use for other investments - and there's a risk, although slight, that the company goes belly up and my friend's investment would be worth $0.
On the other hand, there is a chance that the stock may see $20. It's just hard to tell. Bank balance sheets are rather opaque -- BAC's especially so.
BAC's theoretical book value may justify a price like that, but as we all know, book value stats on banks like BAC are just that - theoretical. And with so many preferred issues, exchange traded debt, and even warrants out there, it's hard to tell what claim to earnings and assets the common shares really represent.
Sell stock. Buy LEAPS calls
One way to continue to maintain exposure to the stock, while reducing risk, would be to replace the stock with long-term LEAPS call option. My friend could sell his stock for $7000 or so and spend $1000 to purchase 10 of the January 2014 10-strike calls (representing 1000 shares at a cost of about $1 per share). These expire in about two years.
That frees up $6,000 to invest in other stocks, or to simply hold as cash. These options would be worth nothing if the stock isn't above $10 per share at expiration, but if the stock trades past that level, these options would gain value at a faster rate than the stock itself. These $1 options would sell for at least $5 if the stock somehow made it to $15 per share
True, the owners of LEAPS call options don't get dividends, but BAC only pays 4 cents per year - hardly worth worrying about, at least right now.
Throwing good money after bad? Maybe. But sometimes it isn't so easy to simply say goodbye to a stock that's been such a downer. That's why, while I'm long BAC, it's through LEAPS options and not the stock itself.
Additional disclosure: I own BAC LEAPS calls