You Recovered Some Of Your Bank Of America Losses - What's Next?

Jan.30.12 | About: Bank of (BAC)

In my article "How To Recover Your Losses In Bank Of America Faster" I showed an innovative way to make some extra gains in Bank Of America (NYSE:BAC) stock in case the stock goes higher. As a reminder, I described a strategy called Stock Repair Strategy. The strategy involves buying a 2:1 ratio call spread while owning 10,000 shares of the stock. The trade was:

  • Buy 100 BAC January 2013 7.5 calls.
  • Sell 200 BAC January 2013 10.0 calls.

The cost to execute this trade was zero and no additional margin was 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. The stock was trading around $5.50 when the article was published. The idea is that if the stock rallies above $7.50, all the gains are doubled by the 7.5 call. However, the gains are capped at $10 by the short calls.

One of the commentators asked me if I'm going to follow up with an article "How to Recover Your Losses from Recovering Your Losses In Bank of America Faster Faster". So now when the stock is up more than 30% and trading around $7.30, I decided to follow up with some alternatives about what you can do now.

So the assumption is the same: you own 10,000 shares of BofA and you think it is going higher. If you don't think it is going higher, you should just sell and take the loss.

The Stock Repair strategy worked nicely so far. The 2:1 ratio call spread which was executed for no upfront cost is worth now $0.30. That's $3,000 gain per 100 contracts, in addition to the gains from the stock. So far so good. If you think the stock is going higher another 30-40%, just keep holding the stock and the spread. The gains will start to accumulate much faster as the stock approaches $10, but will be capped at that level.

But maybe you think the stock is going to double from the current levels? If so, you will miss all the gains above $10. If this is your outlook, there might be a better way. It's called the Short Call Ladder. The strategy looks like this:

  • Sell 1 ITM Call
  • Buy 1 ATM Call
  • Buy 1 OTM Call

In case of BAC, the trade would be:

  • Sell 100 January 2013 $5.00 call options
  • Buy 100 January 2013 $7.50 call options
  • Buy 100 January 2013 $10.00 call options

When the trade is done as a standalone trade, it involves margin requirements since you sell a lower strike (5.00) and buy a higher strike (7.50). However, when combined with the stock, there are no additional margin requirements since the short calls are covered by the stock. In fact, we are getting a credit of $1.10 to execute the trade.

The following table compares the P/L for three different strategies: holding the stock only, Stock Repair and Short Call Ladder.

Stock Price

Stock P/L

Repair P/L

Ladder P/L













































































Click to enlarge

As we can see, the Ladder would work the best if the stock rallies above $10-11 by expiration and the worst if it stays around $7-8. But it will also provide some protection in the $5-7 area.

The choice of the proper strategy depends on your outlook for the stock, but we can clearly see how the proper use of options can increase your gains and give you endless choices based on your outlook. If used correctly, options are a powerful tool for hedging, speculation, and portfolio risk management.

This trade can also be used in a similar way to recover losses and increase gains in other beaten down financial stocks, such as JP Morgan (NYSE:JPM), Wells Fargo (NYSE:WFC), Citigroup (NYSE:C), and many others.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.