Trading Options On Bank Of America's Negative Sentiment

| About: Bank of (BAC)

I have a love/hate relationship with Bank of America (NYSE:BAC). From a trader's point of view, I like to trade Bank of America's stock to the upside or downside due to its high beta and how cheap it can be bought or sold using options. But, outside the realm of investing, I am not a fan of Bank of America's mortgage modification extension that will allow 200,000 homeowners to seek a principal reduction in their mortgages.

As a homeowner since 2007, I understand it does not matter that I pay my mortgage on time and continually seek to beautify my home. If the rest of the homeowners around me don't pay their mortgage and go into foreclosure, then the value of my house won't appreciate as easily or as much over time and the neighborhood will be less desirable. The $25 billion bank settlement over foreclosure abuses can be viewed as a victory for the banks, since having homeowners pay something instead of nothing can help stem further losses for the banks. But for homeowners (like myself) who pay their mortgages on time, there will be no bailout.

Bank of America is the nation's second-largest bank and provides a range of financial products and services. Since the beginning of the year, Bank of America was on a tear from almost going under the $5 area to a high of $9.81 on March 20, 2012. Investors banking on Bank of America since the beginning of the year have been generously rewarded with the progress it has made, but since the March highs, Bank of America has fallen $2.07, or 21%.

While a $2.07 drop does not seem to be much for some stocks, for traders betting on Bank of America's downside using options, this 21% drop from the March highs can deliver some nice returns. When looking at a three-month chart of Bank of America, from a technical standpoint the stock is currently below its 50- and 100-day moving averages. On the current downward trend that Bank of America has been on lately, the stock looks as if it will test its 200-day moving average right around $7.20.

Chart forBank of America Corporation

The Bank of America mortgage modification may be a win for the company, but this may not be a win for Bank of America's share price. Sentiment on the stock can often swing back and forth with the passing of time, and currently Bank of America's market sentiment can be viewed as negative. While having a negative view doesn't mean a stock will trade down, if the negative sentiment persists, this can lead it to making it easier for investors to continue to sell Bank of America. I believe the mortgage settlement pessimism will eventually fade away as Bank of America has, over time, been able to lessen negative consumer sentiment caused by things such as the $5/month debit card fee or fears the big bank may be broken up.

When looking into Bank of America's mortgage modification, investors may wonder if this will really work out or if it will be a short-term band-aid to stem further losses ahead. For people who have a mortgage through Bank of America, in order to be eligible for this program a homeowner must meet the following criteria:

  • Owes more on the mortgage than the property is worth today.
  • Was at least 60 days behind on payments on Jan. 31, 2012.
  • Has a contractual monthly payment for principal, interest, property taxes, hazard insurance and any applicable homeowner association fees totaling more than 25% of gross household income.
  • Has a loan that is owned and serviced by Bank of America, or serviced for another investor that has given the bank delegated authority to do such modifications.

Source: Bank of America.

The 200,000 potential candidates that Bank of America will be sending letters out to may seem like a lot, but in reality there are many more Bank of America homeowners that need help. Also, investors may wonder what kind of precedent Bank of America is setting for themselves. If Bank of America continues the program further down the road, will they be able to offer the same modification assistance that earlier borrowers received? How many homeowners are actually going to participate in the program, and what if the principal reduced still doesn't help? There are many more questions that are likely to come out of Bank of America's mortgage modification program in the coming weeks, and in my opinion this may be a positive for the company, but could put a damper on the share price.

When looking back at Bank of America's charts, the $8 level was a level that Bank of America held from Feb. 7, 2012, to March 12, 2012. The stock was then able to climb higher, making a current 2012 high of $9.81 on March 20, 2012. With the recent pullback Bank of America has seen, the $8 level has not been able to hold over the last couple of days. I expect Bank of America to test its 200-day moving average.

Trade Idea: Buy Bank of America July 9 in the money puts for $1.40 ($1.40 x $100 = $140)

Cost: $140 per 1 contract

Breakeven: Strike price $9 - $1.40 = $7.60

Days Until Expiration: 72

In summary, potential investors will need Bank of America's stock to fall $0.14 to reach the breakeven point. If Bank of America falls to its 200-day moving average near the $7.20 mark, this trade can bring in some decent profits. Even though the breakeven on this trade is small, investors must remember that Bank of America has a high beta and investors can expect to see 2% to 4% upside price swings at times.

To be successful at betting on further downside in Bank of America, investors will need to achieve the best price possible by paying close attention to the technical indicators and price action. Even though I am bearish in the near term on Bank of America, I do expect Bank of America to overcome the mortgage modification obstacle. I would be a buyer at lower levels in the stock.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in BAC over the next 72 hours.