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Thursday, January 15, 2009

Establish Bank of America Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Bank of America covered calls.

This advisor has had Bank of America on my watchlist for a couple of months with a 'buy' target if the price descended to below $10, which occurred today. The recent precipitous decline in the prices of all major bank stocks continues. News late yesterday that BofA was seeking additional capital from the Federal government sent the stock down another 20+% in this morning's trading. With the implied volatility of the call options spiking to above 190, while the one-month historic volatility of the stock was a substantially lower 76, I have the sense that fear and panic were firmly established and that in hindsight this could be a capitulation moment. I thought about Warren Buffett's maxim regarding the courage to buy in times of maximum fear. I also thought about a recent interview I saw in which bond maven Bill Gross talked about investing in areas where the Federal government is investing. Being a Washington observer, I believe the Feds will invest in BofA with additional capital from the TARP(Troubled Assets Recovery Program) and other guarantees sufficient to facilitate its acquisition of Merrill Lynch and in support of its ongoing business model. The extent of BofA's losses and writedowns for the 4th quarter as well as the extent to which it will further reduce or eliminate its dividend remain as two of the many yet unanswered questions until its earnings are released next Tuesday. But with the panic today, this advisor feels there is now adequate opportunity to benefit significantly by selling one-month in-the-money covered calls. As shown below, this high-risk but potentially very high-reward strategy has the potential for a 200+% annualized return-on-investment while providing 26.2% downside breakeven protection. Is the risk worth the potential reward? As always, time will tell.

Established Bank of America Corp Covered Calls for Feb09:
01/15/09 Bought 500 BAC @ $7.929
01/15/09 Sold 5 BAC Feb09 $7.50 Calls @ $2.08

Absolute Return if Exercised: +20.8%
Annualized Return If Exercised (ARIE): +204.6%
Downside Breakeven Price Point: $5.91
Downside Breakeven Protection: 26.2%

1 comment:

  1. I used to think you were a smart guy. This seems incredibly reckless to me.....