The following post is a Guest Blog by CNBC Contributor Brian Stutland.
Bank of America, which helped lead the Dow higher this week, has already doubled this year, and option traders are betting on continued momentum.
BAC was up over 3 percent on Tuesday, and the call-put ratio was a bullish 3.2:1 on heavy option volume. (Read More: Options Explained.)
In one of the day's biggest trades, with the stock at $11.22, one trader bought 4,531 January 12.5-strike calls for $0.09 each. This is a bullish bet that will profit if BAC is above $12.59, or 12 percent higher, at January expiration in 30 days.
So what's behind the bullishness?
First of all, traders are buying BAC on expectations of a "fiscal cliff" resolution. Second, there is the expectation that Bank of America will breeze through the next round of government stress tests. If the bank does pass the stress tests, it will be allowed to raise its dividend from the $0.04 it currently pays.
Meredith Whitney thinks the company could pay out as much as $18 billion, which would be about $1.60 per share. (Read More: Bank Stocks Offer Best Opportunity in Years: Whitney.)
Bank of America currently has $9.87 in cash per share, and trades at 0.6 times book value. BAC also has a more positive debt-to-equity ratio than both JPMorgan and Citigroup, making it relatively attractive in the banking sector.
The only troubling aspect of BAC is that its earnings per share and revenue have been in decline on a year-over-year basis. This has been in line with analyst expectations, but it is a trend that I would like to see reversed.
Because BAC has risen so much in 2012, I would rather buy calls on the stock than buy it outright at this point. Bank of America will report earnings on Jan. 17, just before January options expiration, so the January calls are a great way to bet on those earnings. Call options also remove a lot of the risk of holding stocks through the fiscal cliff negotiations, and allow you to cap your losses if we do go off the cliff.
On the other hand, if there is a solution to the fiscal cliff, BAC is likely to continue its rally into earnings—and if the earnings are good, that will add yet more fuel to the rally. The stock's book value is currently $22.14, and on expectations of a large dividend payout, the stock could rally up to there or even higher. (Read More: Banks Could Have Record Fourth Quarter: Bove.)
Buying January options will be a play on BAC's upcoming earnings. If the options are in the money I would exercise them, and buy the stock to hold through March. I don't have a position on yet, but if I can get a 5 percent or so pullback in the stock, then I might get in. I'll keep you posted!
Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."
Watch "Options Action" on CNBC Fridays 5:00 p.m. ET, Saturdays at 6 a.m. ET and on Sundays at 6 a.m. ET.
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