Tuesday, October 14, 2014

BAC: Volatility play

Update 10/16/2014: I've closed my bear position in BAC as it did some work to the upside, along with the rest of the market, in a reaction to recent declines.

The stock fell -2.1% over the two-day lifespan of the position. That works out to -386.4% annualized.

The option spreads produced a +50% yield on debt, or a (rather ridiculous) +9,125% annualized.

Update 10/14/2014: I've opened a bear position in BAC, structured as described in the "Trade" section. The fill I actually got was less advantageous than when I structured the trade. The new break-even point is $17.19, and the odds of the short leg expiring in the money has increased to 70%. All other characteristics remain as described below.

Bank of America Corp. (BAC), headquartered in Charlotte, North Carolina, publishes earnings before opening bell on Wednesday, Oct. 15. Options volatility holds the promise of a reasonable speculation on the announcement, although history gives a hint of flakiness. (Bank of America in Wikipedia.)


Implied volatility stands at 36%, which is in the 100th percentile -- the peak -- of the one-year range. Volatility has been rising continually since Aug. 19, from 18% to the present high point, doubling in the span of two months. Implied volatility is running 66% above historical volatility.

Options are pricing in confidence that 68.2% of trades will fall between $15.59 and $17.21 over the next week, for a potential gain or loss of 4.9%, and between $16.03 and $16.77 over the next day.


Implied volatility has dropped after three of the last four earnings announcements, although in fairness I must note that never in the past year has implied volatility been so high. The price has also dropped in the three of the four, although sometimes by very little.

The price has presented a series of lower highs beginning Oct. 7.


The Street is anticipating a loss for BAC in the 3rd quarter, compared to profits in the year ago quarter and the prior quarter. It would be the second loss for BAC this year -- the first was in the 1st quarter -- and the worst quarter of the past three years.

The prior two quarters resulted in downside surprises of significant magnitude.


I would structure the trade as a bear call spread, short the $17 calls and long the $18 calls, sold for a credit and expiring Oct. 31. Using the weekly options allows me to give BAC a couple of weeks for its price to move, which seems advisable, given the history.

The short option has a 67% of expiring out of the money, which of course is the goal of a short of options spread. If it expires out of the money, then I can pocket the proceeds of the sale without buying back the spread.

The position provides 5:1 leverage with a $17.29 break-even point, which is 5.4% above Monday's close.

Decision for My Account

The main difficult with the trade is that BAC is a fairly low-priced stock, meaning increased overhead in the form a the small fee for each option trade. It's not a huge amount, but I always keep costs in mind.

Also, the past behavior after earnings announcement has a hint of flakiness, which may signify nothing but which is worth keeping in mind.

Even so, I think it's worth the risk, although I may go for a smaller than usual play -- perhaps half a unit rather than the full unit. I intend to open a very-short-term bear position in BAC if -- and only if -- volatility has begun to hook downward by the half hour before the closing bell.

-- Tim Bovee, Portland, Oregon, Oct. 14, 2014


My volatility trading rules can be read here. For a discussion of the rationale behind the rules, see my essay, "Rules for very short term trades".

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

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Based on a work at www.timbovee.com.

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