Friday, January 7, 2011

Roll Up -- Bank of America Corp.(BAC) Covered Calls

Today, with the four Bank of America Corp.(BAC) Jan2011 $12.50 calls well in-the-money, the Covered Calls Advisor rolled up to the Jan2011 expiration at the $14.00 strike price. With the price of BAC at $14.05, the four Jan2011 $12.50 calls were bought back for $1.61 [only $.11 ($1.61-{$14.00-$12.50}) of time value remaining in each call option]. They were replaced by selling four Jan2011 $14.00 strike options at $.49 as follows:
01/07/2011 Buy-to-Close (BTC) 4 BAC Jan2011 $12.50 Call Options @ $1.61
01/07/2011 Sell-to-Open (STO) 4 BAC Jan2011 $14.00 Call Options @ $.49
Note: the price of BAC was $14.11 today when the limit order to sell these calls at $.49 was transacted.

The Covered Calls Advisor's criteria for when and how to 'roll up' any existing covered calls position are as follows:
1. Roll up when the current equity price is more than 10% above the current strike price; and
2. Make the roll transactions when the current equity price is very close to the new strike price (within + or - $.25 of the new strike price) -- i.e. very close to at-the-money; and
3. Roll (within the same expiration month) if more than 1 week (7 calendar days) until expiration. Roll out to the next expiration month if 1 week or less from the current expiration.
Each of these three criteria were achieved today since:
1. BAC was more than 10% above the current strike price. Note: with BAC at $14.05 today, it was actually 12.4% above the current $12.50 strike price; and
2. The stock price was very close (i.e. within $.25) of the new strike price of $14.00 when the roll-up transactions were made; and
3. Since today is 15 calendar days until Jan2011 options expiration, this exceeds the 7 calendar days threshold. So the options were rolled to the same (i.e. Jan2011) expiration month.

Bank of America's stock performance has been very disappointing since it was purchased in June 2010, but the Covered Calls Advisor maintains his conviction that over the next several months, BAC will increase above its book value to a price above the $16.04 original purchase price. From a valuation perspective, BAC is cheap since it now trades at about one-half of its historic price/book value ratio. Yesterday, Jim Cramer gave ten reasons why BAC is worth buying:
1. Bank of America's chart is incredible compared to what it was in 2007, when it resembled the north face of Mount Everest. Cramer thinks the chart itself is a "screaming buy" and wonders why it is inspiring so much negativity.
2. The bank is well-capitalized and doesn't need to raise more money.
3. Dividend boosts are on the way.
4. Bank of America managed to snag 20% of the mortgage market during the downturn. While having so many mortgages was a liability not long ago, it will be an asset as the housing sector returns.
5. BAC owns the most houses, and will do well in the housing shortage Cramer is predicting for 2012.
6. Fed Chairman Ben Bernanke is determined to keep the banking sector strong, and BAC will be a prime beneficiary, given its "gigantic deposit base."
7. It owns Merrill Lynch. As stocks are looking more attractive now that President Obama is not raising taxes on dividends, more Americans will increase their investments and seek advice from Merrill Lynch's advisers.
8. While the jobs number on Friday may be weak, Cramer would buy BAC on the weakness, since he thinks the long-term outlook for employment is bullish.
9. Fin Reg is over.
10. Now that BAC has settled its claims with Fannie Mae and Freddie Mac, a major risk factor has been taken off the table.

The Covered Calls Advisor agrees. Moreover, Bank of America stock price catalysts in 2011 should include: an improving U.S. outlook, improving loan growth, continuing declines in credit losses, and a gradually steeper yield curve. Despite losses on the BAC covered calls position to-date, this advisor is sticking with the BAC holding and now intends to continue writing BAC covered calls each month.

The overall transactions history (from its inception in June 2010) to the present, as well as a possible return-on-investment result through the Jan2011 expiration are as follows:

1. Bank of America Corp.(BAC) -- Continuation Transaction
The transactions history to date for Bank of America Corp.(BAC) is as follows:
06/21/2010 Bought 400 BAC @ $16.04
06/21/2010 Sold 4 BAC Jul2010 $16.00 Calls @ $.58
07/17/2010 Jul2010 Options Expired
Note: The closing price of BAC was $13.98 on expiration Friday.
07/22/2010 Sold 4 BAC Aug2010 $14.00 Calls @ $.50
Note: The price of BAC was $13.87 today when this option was sold.
08/21/2010 Aug2010 Option Expired
Note: The closing price of BAC was $12.86 on expiration Friday.
09/01/2010 Ex-Dividend $4.00 = $.01*400 shares
09/03/2010 Sold 4 BAC Oct2010 $14.00 Call Options @ $.38
Note: The price of BAC was $13.41 today when these options were sold.
10/16/2010 Oct2010 options expired.
Note: The closing price of BAC was $11.98 on expiration Friday.
11/04/2010 Sold 4 BAC Nov2010 $12.00 Call Options @ $.26
Note: The price of BAC was $11.84 today when these options were sold.
11/20/2010 Nov2010 Options Expired
Note: The closing price of BAC was $11.65 on expiration Friday.
12/01/2010 Ex-Dividend $4.00 = $.01*400 shares
12/02/2010 Sell-to-Open (STO) 4 BAC Jan2011 $12.50 Call Options @ $.34
Note: The price of BAC was $11.59 and the implied volatility was about 39 today when these options were sold. The Jan2011 expiration was selected instead on the usual near-month (Dec2010 in this case) expiration since the option premium of $.17 was below the minimum of $.25 per contract required by the Covered Calls Advisor.
01/07/2011 Buy-to-Close (BTC) 4 BAC Jan2011 $12.50 Call Options @ $1.61
01/07/2011 Sell-to-Open (STO) 4 BAC Jan2011 $14.00 Call Options @ $.49
Note: the price of BAC was $14.11 today when the limit order to sell these calls at $.49 was transacted.

A possible overall performance result(including commissions) for the Bank of America Corp.(BAC) transactions would be as follows:
Stock Purchase Cost: $6,424.95
= ($16.04*400+$8.95 commission)

Net Profit:
(a) Options Income: +$304.30
= [400*($.58+$.50+$.38+$.26+$.34-$1.61+$.49) - 7*$11.95 commissions]
(b) Dividend Income: +$8.00 = 2x($.01*400 shares)
(c) Capital Appreciation (If stock assigned at $14.00): -$824.95
= ($14.00-$16.04)*400 - $8.95 commissions

Total Net Profit(If stock assigned at $14.00): -$512.65
= (+$304.30 +$8.00 -$824.95)

Absolute Return if Assigned at $14.00: -8.0%
= -$512.65/$6,424.95
Annualized Return If Assigned (ARIA): -13.5%
= (-$512.65/$6,424.95)*(365/215 days)

I would appreciate any comments or questions you have on this post -- please click on the 'comments' link below.

2 comments:

  1. I was reviewing your trade on the most recent covered call sell at strike 14. I was wondering why not sell the 16 strike a little further out, since you are bullish on the stock? (ie. April 16 for .48ish). That would give you a 2 point appreciation and make it a profitable trade if BAC continues to move up.

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  2. Carol,

    Thanks for your comment and question -- your suggested approach is certainly a good one. I have found that consistently writing near-month calls every month provides slightly higher long-run total return-on-investment results. Regarding choosing an out-of-the-money strike price, I am likely to do that upon Jan2011 expiration when I select the Feb2011 strike price to sell. But with only 2 weeks until Jan2011, my pre-defined rolling process uses the at-the-money strike price in order to capture the maximum available options premium for the next two weeks.

    Jeff

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