Stress-Free Trade on Bank of America
President, Stutland Equities
On Wednesday, call options on Bank of America were active on above average volume ahead of today's bank stress test results. The biggest trade of the day was the purchase of 13,427 March 12-strike calls for $0.20, which was done with the stock at $11.85. This is a bullish bet that BAC will be above $12.20 (or 3 percent higher) on next Friday's expiration.
Bank of America is poised to pass the Federal Reserve's stress tests with flying colors this time around, which could open the door to a possible dividend increase and stock buyback.
Currently, among America's largest banks, Bank of America is the best capitalized one, with a Basel III Tier 1 common capital ratio of 9.25 percent. The minimum required is 5 percent, which leaves Bank of America with a comfortable amount of excess capital, some of which analysts expect could be allowed to be returned to shareholders. Analysts at JPMorgan estimate that Bank of America could increase its dividend from $0.01 to $0.04 and buy back up to $4 billion in stock. However, news about possible dividend increases will not come until next week.
This trade is a short-term bet that Bank of America's stress test results will be better than expected, and that the bank will then be given permission to begin returning capital to shareholders.
If expectations are not met, the stock could sell off or simply stay put, which is why this trader chose to buy short-dated calls instead of simply buying the stock. If BAC does increase its dividend and announce share buybacks, these calls could easily expire in the black, in which case they would be exercised into a long stock position that could be held to collect the dividend and capture what could turn out to be a continuation of the long-term rally in the financial sector.
If I can get some of these calls at a decent level, I will be looking to add a BAC position, but I haven't done anything yet.
Disclosures: None to report.
—Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."