A Bank Of America Option Trade That Minimizes Risk

| About: Bank of (BAC)

I have written a couple of articles on Seeking Alpha about Bank of America (NYSE:BAC) in the last couple of months about the risk associated with owning the stock or call options, which you can read here and here.

As I have stated in my previous articles, I am not so sure Bank of America is done moving much lower in price, but I do hold a more bullish bias than a bearish one. There are still many unknowns involved regarding the current and possible future lawsuits with bank of America, along with the overall health of the bank itself. Currently, nobody really knows if any more detrimental news is going to come. With that being said, Bank of America also offers tremendous upside from its current price.

Bank of America is currently trading at $5.64/share. The 52-week range is $5.03 - $15.31.

52wk high: 15.31
52wk low: 5.03
EPS: -0.33
Div Rate: 0.04
Yield: 0.70922
Market Cap: 57.17 B
Volume: 283.13 M

I believe that the Bank of America is not going to stay in the current price range that it is in right now, and this is why I think the 'short call ladder' option spread can take full advantage of this. For explanation purposes, I will use one (1) contract on each "leg" of the trade.

Short Call Ladder Construction

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

The 'short call ladder' spread is a limited risk, unlimited profit trade. Although you initially will receive a net credit when placing this trade, the upside potential is not limited to how much of a credit you received when initially placing the trade. This is because if the underlying stock price rallies explosively, potential profit is unlimited due to the extra long call, which distinguishes the 'short call ladder' spread from many other credit spreads.

I view this trade as a security blanket in case Bank of America should continue to fall more than it already has, which is very possible. In essence, the 'short call ladder' spread provides the trader the ability to profit on either side of the trade.

Here is how I will be setting up this trade, using 100 contracts on each "leg".

  • Sell 100 March 2012 $5.00 call options
  • Buy 100 March 2012 $6.00 call options
  • Buy 100 March 2012 $7.00 call options

Entered Trade

Price Cost
Sell -100 BAC Mar12 5 Call $1.15 ($11,500.00)
Buy 100 BAC Mar12 6 Call $0.63 $6,300.00
Buy 100 BAC Mar12 7 Call $0.31 $3,100.00


Cost/Proceeds ($2,000.00)
Option Requirement $10,000.00
Total Requirements $8,000.00
Estimated Commission $375.00

Here is the profit/loss chart for the trade:

Current Price: $5.64

Price Profit / Loss
3.75 $2,000.00
4.71 $2,000.00
5.00 $2,000.00
5.20 $0.00
5.72 ($5,200.00)
6.00 ($8,000.00)
6.73 ($8,000.00)
7.00 ($8,000.00)
7.74 ($600.00)
7.80 $0.00
8.75 $9,500.00

The option requirement to place this trade is $10,00.00. However, the actual total requirements is $8,000.00, plus commissions. The break-even points on the trade are $5.20/share and $7.80/share, respectively. With over three months remaining until these options expire, I see this as a very safe trade to make with a lot of potential.

You can also choose to increase the amount of contracts on each "leg" of the trade to gain higher profits or you can decrease the amount to limit your total investment.

If Bank of America should inch towards $9.00 or $10.00 a share by March 2012, this trade will be a huge success.

In summary, if you are looking to minimize risk and possibly capture unlimited profit, the 'short call ladder' spread makes a lot of sense. This trade can also be used effectively on other securities where there is a bullish bias, but with concern for more possible downside. Other names in the financial sector, such as JP Morgan (NYSE:JPM), Wells Fargo (NYSE:WFC), Citigroup (NYSE:C), and many others that have been hit very hard due to the Eurozone crisis and other concerns are some other obvious choices.

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

Additional disclosure: I will be opening a 'short call ladder' spread on (BAC)

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Tagged: , , Regional - Mid-Atlantic Banks, Options
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