3 Reasons BAC Warrants Look Pretty Sexy
I’ve traded BAC / BACWSA often since the warrants began trading. Sometimes I’m long warrants and short common, sometimes long warrants and short calls, and sometimes just long warrants. I’ve had an interest in the banks ever since I did a consulting gig at the FDIC helping them learn how to wind down large financial institutions.
Right now I don’t have any particular insight into BAC as a company, or a particular view on where the stock is headed. But, I do lean toward the idea that it is currently undervalued, as similar financial stocks appear to be on a long term, historical basis.
I’ve just put on a position that I like here, and this is what it looks like. Long BACWSA, at $7.10, short BAC Nov. 22 Calls at $.16. I like this position for three reasons.
Rolling the Calls Should Provide a Good Dividend
Given that market volatility is elevated, these calls give me a nice premium / faux dividend on my warrants. I take in 2.25% over 30 days on a $7 equity.
As I roll this each month I assume I won’t get that 2.25%, or $.16, each month. Conservatively I assume I’ll average $.10 per month on the calls, or $1.20 over the course of a year. That’s a 17% dividend on my $7.10 warrants.
Yes, the value of the warrant premium will decrease over that one year period, but not significantly. And yes, I could be taken out of my position (or put into a hedged long warrants / short common position) if the stock rises through my call strike. Fingers crossed on that one.
I’m Using the Recent Low as Support
I have three very clearly defined support levels at which I can reassess my position if the stock heads lower. $15.40, $14.80, and $14.40 are very clear support levels (at least to me…side note, if you have trouble understanding technical analysis, and think MACD is something you get at MCDs, take the time to learn just one thing, how to judge support and resistance…maybe that’s two things).
I can use these levels as stops, or to add to my current position depending on market conditions should the stock reach this level.
This Position Can Make Money in a Range Bound Stock
Once BAC shot above $15 late last year, it’s been range bound between $15 and $18 (except for a short trip to $14.50 in mid-May) ever since. Nothing tells me that it’s going to break out of this range anytime soon, and since Yellen and Gross aren’t on my speed dial, I don’t have much insight into interest rate moves.
But, that’s OK. If the stock does absolutely nothing for the next year, and I only collect my call premium each month, I’ll take it.
Additional Resources
When I originally published this post I had several questions around the process / outcome of shorting call options against warrants. While this may seem like an exotic trade it is actually very much like a covered call or a calendar spread.
The advantage over a straight covered call is that you can get more leverage with the warrant, because of the lower price. The disadvantage, versus a covered call is that there will be some premium decay in the warrant. But this will be much less than the premium decay in the near term calls your are short (which is profit to you).
It is similar to a calendar spread in that you are buying a longer term option (the warrant) and selling a near term call to collect the premium. If I were forced to pigeon-hole the trade I’d say it’s a little more like a calendar spread than a covered call.
You can find additional information on covered calls here, and on calendar spreads here.