Sam Zell was recently on CNBC, listening to the usual palaver about everything that could go possibly go wrong in the world at any moment. Finally, the blunt-talking, self-made billionaire made an important point about market pundits.
“We predicted that it’s going to be this, and we’re worried about this, and we’re worried about that, and meanwhile the game keeps going,” said Zell, who made his fortune in real estate.
Real money is often made when others think there isn’t any opportunity and the risks seem high. The saga of Bank of America (ticker: BAC), which was almost destroyed during the global financial crisis, illustrates the lesson well.
In the past decade, the bank’s stock price has doubled and tripled and then some. This column long championed the stock during its darkest hours, and has never stopped. We recommended buying the stock and using upside call options to supercharge the advance since Bank of America, now at $29.46, was in the single digits. (Calls increase in value when the associated security rises.) Since then, CEO Brian Moynihan has turned the bank into a powerhouse, and Warren Buffett has become Bank of America’s largest shareholder.
Amid talk of a coming recession and expectations that the Federal Reserve is about to lower interest rates again—theoretically crimping financial stocks—it’s important to remember that buying stuff that is wildly out of favor is historically a great way to make money.
True, BofA, like other financial stocks, has recently popped higher, but it seems unable to definitively rise above $30. And now J.P. Morgan is telling its clients that BofA’s stock should shine.
Shawn Quigg, a derivatives strategist, predicts that the stock could rally on a combination of progress on the trade war, an accommodative Fed, a steepening yield curve, or even hedge funds adjusting portfolios, which could trigger a style rotation into battered stocks, sparking a chain reaction of short covering, fundamental flows, and equity long-short portfolio rebalancing by quantitative investors.
Investors could consider buying Bank of America’s October $29 calls that expire on Oct. 25 for $1.26. The trade positions investors at the forefront of potentially favorable events and lets them take advantage of cheap implied volatility.
Bank of America’s one-month at-the-money options are priced without a greed premium, even though there might be a lot to be greedy about. If the trade works, and the bank pops to, say, $33 by expiration, the call is worth $4. If the stock is below the strike at expiration, the trade fails.
During the past 52 weeks, BofA stock has ranged from $22.66 to $31.37 and is down 3.2%. Shares are up about 20% this year, on par with the S&P 500 index.
To be sure, the single most important thing about Bank of America is arguably that it is a well-run company with a CEO who knows his business because he rebuilt it after his predecessor nearly destroyed it. The stock’s 2.46% dividend yield is like a cherry atop a sundae.
A textbook could be written about all of the risk factors facing the financial sector, but if interest rates are lowered and money flows into stocks, as predicted, just about anything should advance, especially stocks with competitive yields—even if the associated company’s business is challenged by the drag of lower rates.
If Moynihan embraces the moment and does more to boost the dividend and buy back stock—rewarding everyone who stuck with him through the nasty days—BofA will pop even higher.
Sound intriguing? Consider following J.P. Morgan’s call trade, or just buy the stock and sell some puts that expire in six months with strike prices just below the stock price.
These days, investing is too often discussed like a sporting match or to get people to click on website links. Regardless of what happens in the short term, people will always need to borrow and manage money, and the game will keep going.
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