Bank Of America's Stock May Be Heading For A World Of Pain

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About: Bank of America Corporation (BAC), Includes: XLF
by: Mott Capital Management
Summary

Bank of America's stock may be heading lower based on options betting.

Interest rate spreads continue to contract.

The technical chart is very weak.

Bank of America's (BAC) stock may be heading lower in the weeks ahead. The company's revenue could come under considerable pressure as the yield curve continues to drift lower and spreads contract. Options traders are betting that the stock price falls by at least 9% by the middle of September. I first noted this bearish activity in a Marketplace article for my Reading The Market subscribers on August 8, Big Bets Bank Of America's Stock Plunges

Bearish Betting

The $26 put options for expiration on September 16 saw their open interest levels rise by almost 20,000 contracts on August 8. According to data from Trade Alert, those put options traded on the ASK, which indicates they were bought, a bet that the stock will fall. And, no, in options trading, there isn't a seller for every buyer. Options markets are not nearly as liquid as the equity market, so the seller was likely a market maker, who turns around and hedges away the risk. For a buyer of those puts to earn a profit, the stock would need to fall to approximately $25.65. That would be a decline of about 9.2% from the stock's price of around $28.25 on August 8.

But even worse, the $26 Put options for expiration on October 18 saw their open interest level rise by over 30,000 contracts on August 8 as well. According to data from Trade Alert, those puts also traded on the ASK, indicating they were bought. The stock would need to fall even further for the trader to breakeven, by nearly 10% to roughly $25.45.

If it is possible, it could be even worse. Because yesterday, I noted in another article, there was bearish betting taking place in the Select Sector SPDR Financial ETF (XLF). It would seem that sentiment is turning negative not just for Bank of America but the entire sector, Don't Expect The XLF Rally To Last.

It Is All About The Spread

One can't blame investors for being so negative on the group either. The yield curve has not only flattened, but it has inverted at points, which should come as no surprise to anyone. The chart below is something that I provide to my subscribers in my Marketplace service. It shows you how dramatically the yield curve has shifted over the past year and how much rates have fallen in the process.

Additionally, the spread between long-dated and short-dated maturities continue to contract. One such measure is the 10-year yield minus the 2-year yield, which has contracted to just ten basis points. That is the narrowest the spread has been a long time.

However, other parts of the yield curve are already inverted, that is bad for a bank's net interest income. Remember, banks borrow short and lend long. That means that a bank will borrow more from the depositor and pay them a low-interest rate and lend money long term to a borrower and receive a higher rate, creating a spread. However, as that spread contract, the ability to generate income contracts as well.

The 5-year minus the 2-year yield is already inverted and has been for some time.

Weak Chart

The technical chart of Bank of America is very weak. The stock has failed on two occasions to break out and rise above technical resistance at $31, which could be a sign of a bearish technical pattern known as a double top. Now, the stock finds itself sitting at an essential level of technical support at $28. Should the stock fall below this level of technical support it could drop to as far as $25.75, a decline of almost 9%.

It would seem that Bank of America's stock may be heading for a world of pain over the next several months. Especially, if the yield curve continues to flatten and in some case invert more steeply. Should this happen, it will not only push Bank of America's stock lower but the entire sector.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.