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Time To Protect Your Gains In Bank Of America

|About:Bank of America Corporation (BAC)

Recently, Bank of America (NYSE:BAC) has had a good run. As of March 26th, it was up 80% off its May 21, 2012 close of $6.83. And up 6% year to date. The US banking sector appears to be getting its house in order after suffering through the financial crisis in the fall of 2008. Even after the recent run, Bank of America looks attractive. At its current levels, it is far from its pre-crisis highs of over $50 per share, and is trading at a forward PE of only 9.31 and a 5 year PEG ratio of only 0.67. But in this continued slow growth environment and with the uncertainties surrounding US employment, the housing market and the European economies, could this run be too much too fast? This may be a good time to add some protection to your portfolio and limit the downside risk to your investment in BAC.

Protecting Your BAC Position With Puts

One component of an option's price is volatility. The higher the volatility, the higher the odds of an option strike price being hit and therefore the higher the cost of the option. At just 12.77, the S&P 500 Volatility Index (VIX) is near a two year low making the cost of options relatively cheap. In this environment, options offer a cost effective way to hedge your long position and protect your portfolio.

VIX 2 Year Chart

VIX 2 Year Chart

Source: Yahoo Finance

You may consider purchasing out of the money puts to hedge your long position and protect your assets should Bank of America pull back. You can think of buying covered puts like buying insurance. If the disaster hits, the insurance will pay off. If the disaster is averted, the insurance is considered a cost of doing business. Remember, when purchasing options, each contract is for 100 shares. So if you are long 200 shares and want to hedge those shares with a put option for each share, you would purchase 2 put contracts.

Following are recent put option prices for Bank of America which may be used to hedge a long position.

BAC

Put Strike Price

May 2013

Expiration

Ask

June 2013

Expiration

Ask

July 2013

Expiration

Ask

$10.00

$0.05

$0.10

$0.15

$11.00

$0.15

$0.25

$0.34

$12.00

$0.43

$0.57

$0.69

$13.00

$1.00

$1.13

$1.24

Source: Yahoo Finance

Protecting Your BAC Position With A Stop-Loss Strategy

Another strategy often deployed to protect assets when the odds of a pull back are on the rise is to set and maintain a stop loss order. You can set a mental stop price and react when the equity pulls back and hits that price, or be proactive and actually set and maintain a stop-loss order with your broker.

Whether deploying a real or mental stop loss, the key question when deploying a stop-loss strategy is, at what price should I set the stop-loss trigger? Too tight and you may be stopped out prematurely and miss out on continued gains. Too loose and the purpose of the stop-loss is defeated as you give too much value before it triggers. To address this chalenge, SmartStops.net publishes optimized stop loss prices daily for stocks and ETFs. The stops take into account the equities individual volatility and recent trading pattern. They are designed to trigger only when abnormal price weakness is detected. SmartStops publishes both an aggressive short term signal as well as a conservative long term signal.

For Bank of America, the SmartStops published for use on 3/27 were as follows:

Bank of America

Closing Price

March 26th

BAC Aggressive

Short Term

SmartStop

BAC Conservative

Long Term

SmartStop

$12.28

$11.76

$11.14

Source: SmartStops.net

We all make purchase decisions on a risk vs reward basis. Unfortunately, risk does not remain constant over time. It is prudent therefore to monitor your risk levels and take action to manage your exposure when risk is on the rise.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Stocks: BAC