So is this the bottom for financial stocks? If it is then they made a heck of a bounce on Tuesday. The rally happened faster than a speeding bullet and the Wall Street cheerleaders have got this pep rally going. Yeah!
Before we go jumping in and buy any options lets look at how things turned around so fast. To start, getting rid of the “uptick rule” will be huge. It just might make the bears or people who short stocks go into hibernation because it is going to be that much harder to short stocks. For those of you who are unfamiliar with the uptick rule, it is a rule that was lifted which made it easier for short-sellers to short stocks. Before, an investor would have to wait for a stock to make an “uptick” or a gain before they could short it.
Lets say ABC stock is at $15 and you want to sell 100 shares short because you thought the stock as going to go down. If the stock’s last trade was to the downside, you would have to wait until it gains a penny before you can short it. That might not make sense to you but just look at it this way.
As all of these financial stocks have been going down, it has been easier for the short-sellers to pile-on to the downside because the uptick rule was lifted. Now short-sellers will have to wait for a positive trade before they can short the stock.
Next, a lot of today’s rally was short-selling covering which means these same short-sellers were covering their positions. We also got other good news concerning the financials and there is a lot going on this week in Congress as well.
Wall Street is hoping that a congressional committee meeting on Thursday will move to temporarily relax “mark-to-market rules”. These rules have caused banks and financial firms to incur massive write-downs, which have driven losses, destroyed capital and knocked share prices down 40% on average.
The reality is nothing changed with the economy in the last 24 hours.
I’m not a big fan of Bank of America (BAC, $4.79, up $1.04) because of its toxic assets which nobody knows what they are worth. However, there is some incredible option activity worth noting.
Instead of trying to figure out where BAC is going to finish the week or month, lets go out until May. There are circles in Wall Street that firmly believe this is a double-digit stock but are you willing to pay $5 a share on the unknown? I’m not but I do think the sell-off has been severe and many of these stocks are due for a bounce.
If the talk of BAC is that it is going to $10 or higher, well, lets go under that and say the stock has a shot at $8. The stock was at $7.81 in January and above $7 in February. So $8 is possible especially considering the stock was at $14 to start the year.
The May 6 calls (BYOEF, $0.97, up $0.42) opened at 75 cents and traded nearly 24,000 contracts.
If you buy these call options they will be impacted by Thursday’s news, first quarter earnings and all of the other verbage that comes out of Wall Street. Now, if you really believe Bank of America will be at $8 by May 15, 2009, the good news is that these options will double. And the quicker BAC moves higher, the quicker these calls will be “in-the-money”.
If we take it a step further, if the stock is at $10 by the middle of May, these calls would be worth at least $4 or 300% higher from current levels. To get that same return from the stock, BAC would have to be at $20. That my friends is the power of leverage and the power of options.
The July 10 calls (JLWGB, $0.30, up $0.08) traded over a 1,000 contracts. If the stock is at $12 by July 17th, 2009, these options would be at $2. That means for every $30 you invest right now COULD be worth $200 by July. If you “bet” $300, you could “win” $2,000.
If BAC is at $14 then the July 10 calls would be worth $4 and for every $30 you invest now…it would be worth $400! If you bet $300, you could win $4,000. Wow…
These are the facts and this is the simplest way to look at things. I’ve gotten a slew of emails concerning financial stocks over the past few days and BAC’s name keeps popping up. I would go with the stronger names if I were doing an option trade but this is a very nice risk/ reward trade that even Charles Barkley would be happy with. The downside is that BAC stays below $5 and you end up with a big loss.
I like both trades for very, very…very aggressive accounts only.
Thanks for the emails and keep them coming, please…
Rick Rouse
Rick@OptionsMentoring.com
