Are Bank of America $29 Calls Such a Bargain Now?
You don’t see all that many articles on options plays in the popular financial media, but Barron’s columnist Steven Sears is known to provide a few, and has another for us now.
Not a lot of people invest in options, and with good reason. They just don’t know their way around options and may not even know the difference between a call and a put in many cases. Options trading also happens to be the most challenging and complex form of trading that there is, as far away as one could get from the strategies employed by the great majority of investors.
Not everyone who reads these articles are investors though, and some may know enough about what they are doing and may have enough experience to want to at least have a look at whatever picks are offered in these pieces. There may even be some who know little or nothing about options but may reason that if the pick is good enough for Mr. Sears, who actually does have at least some knowledge and much more than they do, it is good enough for them.
We never just want to assume that if someone is accomplished enough to be hired by Barron’s or some other popular financial media outlet to write these articles, they must be good and surely worth risking some money on. We should never be investing or trading without having some means of being able to tell the good plays from the not so good ones, so if we are eager or at least open to trading this, we need to have a look at it to see if this is indeed something we should want to trade.
One of the first things that we need to get out of our head is the fact that what is going on that may impact a stock or other asset we’re trading after the expiration date is not meaningful to our trade. Bank of America may look fabulous long-term or it may look very shaky over this time but that’s not the time frame we’re trading in at all here, so we don’t want to become confused or let factors not pertinent at all to the trade influence our decisions.
We might be impressed at how far Bank of America stock has come in the last 10 years, but how much it moves on charts this big isn’t really pertinent to the one we need to be looking at, the short-term one, because betting on a stock’s price between now and October 25 means that we need to know how it’s moved in the much more recent past and have us looking at its chart over the last few months only.
It is still good to take a little broader view such as the last year to become aware of any resistance points that may be out there that are beyond the left edge of our charts, but longer than that out, resistance points just aren’t that persuasive in a trade as short of a term as a month.
We can at least gain some knowledge from the fact that B of A stock has so much room to its highs in 2006, and it is at least looking like it wants to go back above that if not for the notable amount of resistance in the $31 area. On the other hand, any further moves towards the $53 area is going to be pretty modest at best over the next month, so regardless of how much room there is, its movement to the upside is going to be pretty limited in this case.
Steven Sears Likes B of A $29 Oct. 25 Calls Now, Should We?
Sears recommends buying B of A $29 October 25 calls here, and describes the premium as being non-greedy. Premiums are never greedy per se, but can be higher or lower depending on the perceived risk to the options writer. The higher the risk, the higher the premium, but the lower the premium, the less the upside as a general rule, and therefore we need to be careful with apparent bargains.
This trade would be seen as less risky for options writers than most, and it is because of the fact that this options call would be bumping up against resistance that defines this the most. We’ve already tried and failed to get past this level this year and have come up short each time, and this is during a year that has been pretty bullish overall compared to your average year in the stock market.
In April, the stock made it to $30.71 and faded, and then in July it attempted to break through this level again and stalled at $30.77. This does not mean that the third time won’t be the charm, but having this bar set just a little above our heads and right at the strike price plus the premium as it turns out should definitely give us pause. We are paying for the chance it will break through this wall and the cost may be low but the opportunities tend to be as well with this sort of play.
If we were really looking to cash in on a call with this stock, after it bounced off the $26 level for the third time this year in mid to late August, where it languished for a couple of weeks, would have been a much more opportune time. This stock has been really trading in a range and it would make more sense to take a flyer on it with a call at a time where we’d also want to be entering the stock as well.
Once September hit, it rose $3 so far, and this looks much more like a chase near the top of a range than anything, and actually, this is exactly what Sears’ play seeks to do. You don’t want to wait to buy stocks that have moved up toward the upper end of their range, as at this point, the options are to either wait to see if it breaks through or wait for it to reverse course.
When we are paying a premium for this, where if it doesn’t make it, we will lose all of our money, even if this is only a 6% loss compared to the value of the stock, that’s still a significant amount versus just watching it spin its wheels. We are leveraging here so it bears in mind that this goes both ways, and options within a certain range magnifies our losses as well, for instance with it falling a little below $29 and our losing 6% on the trade versus losing only a percent or two if you were long the stock and this happens.
Nominally, this may not seem to matter, as a $1.49 loss per share, where the ask is now for this contract, isn’t that big of a deal, but this does add up and we always want to make sure that our money is being deployed wisely and in a manner that should produce positive gains over time.
The Better Move Would Be to Take the Other Side of this Trade
This trade simply does not cut it, and in fact this would actually be a good move to fade if you own the stock and sell calls, where you get to keep the premium if the resistance holds like it likely will and only be exposed to a dollar or two of potential losses if something does wake it up more than we expect over the next month.
There is usually some sort of over expectation with buying options, dead money in other words, and writing options is often the smarter side to be on, although that really does take skill and is not really something investors want to dabble in unless they know how to react if things don’t go their way. Options writers who don’t manage risk properly is the dead money on that side of the table and we don’t want to be sitting among them either.
Buying options can be plenty profitable though if you pick your spots well enough, which is nothing like just looking at some stocks you like and figure that if they have been good investments, they should be good options plays as well.
If you are skilled as a stock trader, you at least have some basic knowledge to be able to separate the wheat from the chaff, and this is not a play from the stock side that a trader with any real skills would want to touch. If it isn’t a buy on the stock side, it surely isn’t on the options side, where you have to see your play move enough to even get even and not see you lose your entire stake in it.
If we really do want to play this, the only interesting thing about it is that the company’s earnings are due on October 21, which puts this within our window for this expiration date. Buying calls ahead of something like this can be a good move at times, as if we buy a call then, we’ve well defined the risk, unlike the people holding the stock, and could take a flyer on it pretty cheaply.
If you want to write these calls, this is the time where you want to be out of it, because that’s where the potential for gains for the buyers kick in and the potential for losses for you.
This is an example of a sensible options strategy, and we really need a reason to do options rather than buying the stock, and a good reason doesn’t include looking to get paid more if you are right, as tempting as their being leveraged so much may be. Leveraging can be very nice as long as we’re leveraging skill and the lack of it.
Options trading is a lot like poker, where if you don’t know who the dead money is, it is you. The money with options flows from the weaker players to the stronger ones like it does in poker, only it happens more quickly and without the same degree of randomness that you see over time with poker playing. Good poker players also have to know when to hold them and know when to fold them, and this is even more important if anything with options.
With holding stocks, everyone can win because it is not a zero-sum game like options is. Stocks can just keep going up and even random picks can make a lot of money over time. With options, you have to beat your competition, the other options players, and if you are a below average trader you will be sitting with the dead money in the game.
One of the things about options is that it costs you money every day, and without much at all having us think that this stock will bust through until then, it’s better to let other traders see their premiums decay and take this gamble at a lower cost.
We still need to time our options entries and this is even more important with options than with stocks. Even this does not promise any kind of big payday though, as we’d just be looking for the gap to tighten and then use it to possibly gain some value should the stock pop in the final days of the contract.
Other than that, this is simply not a good options play, whether it works or not, because our task is to assess the likelihood of this working and its profit potential, and this play has neither in enough measure at the present time that we should want to join Sears in chasing this.
If we instead look for good trading opportunities for the stock and look to ride its potential and momentum at a time where there is more of both, then buying calls on stocks can work and work pretty well at times. We don’t necessarily want to be shooting for home runs, because we’ll strike out too often, but if the best we can do is draw a walk, those plays just don’t have enough upside to want to risk our premium on, as modestly priced as it may seem.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
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