We wrote an article on Aug. 7 in which we put forth a strategy that enabled investors to leverage their positions in Bank of America (NYSE:BAC) for a relatively low fee. The suggested strategy was a relatively low-risk strategy because the stock had also just completed a double-bottom formation on July 23 and was trending upward. Double-bottom formations are generally bullish and usually lead to higher prices. This outlook seems to have come to pass as the calls are showing gains of almost 330% and the put options we sold are almost worthless.
In that article we made the following comments:
It has started to put in higher lows since the end of this May. This is usually a bullish formation and could lead to a sharp move above the $8.00 range. The 8.00-8.10 ranges offer a pretty strong zone of resistance, so a nice break out on strong to decent volume would be a very bullish development. Even more bullish would be a weekly close above 8.22. If this comes to pass it should push the stock to the 9.50-10.00 ranges.
The stock closed above $8.22 on Sept. 6 and traded as high as $9.79, trading within our suggested target range before pulling back. The stock could trade past $10.00, but time is running out on the call options as they are set to expire this month.
We advised readers to purchase the December 2012, 7 puts in the article we put out on Aug. 7.
The Dec 2012, 7 puts are trading in the $0.42-$0.43 ranges. There is a good chance that the stock could pull back to the 7.40-7.50 ranges before trending higher. If this comes to pass the puts should trade in the 0.50-0.60 ranges. However for this example we will assume that the puts can only be sold for $0.45 or better. For each contract sold, $45 will be deposited into your account.
Click to enlarge images.
We stated that the stock could pull back to the $7.40-$7.50 range, and that the options could trade to the $0.50-$0.60 ranges. We instead used a price of $0.45 as the price the puts could have been sold for. The stock traded lower on the following day, and the options traded within the suggested entry price ranges. Those who wanted to open a position should have managed to sell the puts at $0.45 or better.
In the same article, we also noted that investors could purchase the October 2012, 9 calls that were trading in the $0.09-$0.08 range. Even though we stated that the calls could drop in price if the stock traded to the $7.40-$7.50 range, we listed a purchase price of $0.08 for the calls.
The Oct 2012, 9 calls are trading in the $0.08-$0.09 ranges. If the stock pulls back to the suggested ranges the calls could trade in the 0.05-0.07 ranges. For this example, we will assume that we can purchase these calls for $0.08 or better. For each put sold you will be able to purchase up 5 calls and have a net credit of $5. Note if you are bullish on the stock and do not want to wait, you could put this strategy to play right now. If you work the option you might be able still be able to purchase as many as 5 calls for each put sold. You could definitely very easily purchase 4 calls and have some money left over immediately for each put sold.
As the stock traded even lower the following day, it should have been very easy to purchase the calls at $0.08 or better.
What Are the Options Doing Right Now?
The December 7, 2012 puts are trading in the $0.04-$0.05 range. At this point, they have shed almost all their value, and it makes no sense to hold them until the end. We would close this position out and walk away with a gain of $41 per option. In essence, you will recoup almost all your money, except for $4.00. The puts were originally sold for $0.45 and if you purchase them back now you will be doing so at roughly $0.04.
The October 2012, 9 calls are trading in the $0.35-$0.36 range. They traded as high as $0.49 today, so it should be possible to get out in the $0.36-$0.40 range without too much trouble. As there is not much time left on this option, we would book the profits now and walk away with gains in the 330%-400% range depending at what price you close the position out. Note that by purchasing the puts back we recovered almost all the money that was used to fund the call of these options. In essence, we sold the puts for $0.45 and purchased them back for $0.04-$0.05. When you factor this in, the profit factor is significantly higher.
The puts have lost almost all their value, and the calls are showing gains in excess of 330%. As there is not much time left on the calls and the puts are almost worthless, investors should close this play out. With such lofty gains in hand, it makes no sense to push the envelope and try to squeeze more out of this play. When the profits from the puts are factored in, the total gain if the position was closed out right now would exceed 330%.
Options tables sourced from Yahoo Finance.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: This article was prepared for Tactical Investor by one of our analysts. We have not received any compensation for expressing the recommendations in this article. We have no business relationships with any of the companies mentioned in this article.
Disclaimer: It is imperative that you do your due diligence and then determine if the above strategy meets with your risk-tolerance levels. The Latin maxim caveat emptor applies -- let the buyer beware.