Bank of America (NYSE: BAC) was once one of the proudest American banks.
Acquisition after successful acquisition led to soaring profits and a skyrocketing share price.
For a long period in late 2007 and early 2008, the shares comfortably coasted above the $40 mark.
Then came the financial crisis of 2008 and Bank of America was at the eye of the hurricane.
Its shotgun wedding with Merrill Lynch and previous acquisition of Countrywide Financial put it at the epicenter of the U.S. housing crisis.
That’s why many investors still think of the stock as “damaged goods.”
But even in its shrunken state, Bank of America is still a financial behemoth.
Fundamentally, the approximately 30 analysts who cover the stock project that a strong earnings turnaround is in progress.
Revenues are expected to stay essentially flat at $90.57 million in 2012 and $91.98 million in 2013.
However, 2012 earnings are expected to be $0.55 per share, compared to $0.01 the prior year.
By 2013, they are projected to grow 65.4% to $0.91, providing a tailwind for a rising share price.
Below is a daily chart that emphasizes the nearly five-month-long basing pattern the stock has been forming.
The first thing to note is the rising bottoms that characterize the stock. The shares hit $6.70 in late May, retested this level at $6.84 in early June, and on another retest probed $6.89 at the end of July.
Since that time, the bank has been on a tear. It tested the late April $8.38 resistance level in mid-August, failed and backed off to $7.82, but is once again probing the $8.40 level.
The technical pattern is a bullish ascending triangle. The uptrend line drawn from the late July $6.89 low currently passes through the chart at about $7.90. The height of the base is approximately $1.70 ($8.40 -$6.70). That means if BAC does break out of the pattern, according to the measuring principle, it should have a target of just over $10 ($8.40 + $1.70 = $10.10).
I’m doing things a little different this week. I don’t plan to only trade shares of BAC. For the first time in Trade of the Week, I’ll be using a two-step trading strategy designed to lower risk… a covered call trade that offers 21% upside potential.
My plan is to add BAC at the market open on Monday and write one May 2013 $10 strike for every 100 shares added.
For example, BAC closed on Friday at $8.80. For every 100 shares added to the portfolio, I would write one May 2013 $10 strike call, which last traded at $0.63 on Friday. Since each call is the equivalent of 100 shares, I’d receive $63 in options premium.
The $0.63 options premium means the trade will be in the red if shares fall to $8.17 or below ($8.80 – $ 0.63 = $8.17). If this were to happen, then the stock would break both its trendline off the late July $6.89 low, as well as fall below the $7.82 pullback it underwent in late August — there would be little technical justification to continue holding the stock.
I am setting my stop-loss at $7.79, just below the $7.82 reaction low. If the stop-loss is hit, I would buy back the call to close the option position at a minimal loss.
If the shares continue to rise, two scenarios could play out:
1. BAC hits $10 before the third Friday in May and the shares are called away. In that case, my profit is 21% ($10.00 -8.80 = $1.20 profit + $0.63 option premium = $1.83 and $1.83/$8.80 x 100 = 21%).
2. BAC trades consistently below $10 until the third Friday in May, and the calls expire worthless. That trade would have generated a $0.63 premium, which at current prices is just under 7% of the stock price. If the stock has continued its uptrend, the price appreciation will be on top of that.
Action to Take: Based on the analysis above, here’s how I plan to trade BAC:
- Buy BAC at the market open on Monday, Sept. 10
- Sell one BAC May 2013 10 Call for every 100 shares purchased
- Set a stop-loss for BAC at $7.79 (if hit, I’ll buy back the option immediately)
- Hold BAC until options expires in mid-May or BAC hits the $10 strike price
– Dr. Melvin Pasternak
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Source: Trade of the Week