(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
Bank of America Corp. (BAC) is expected to report first-quarter results on Monday, before the open of trading. Some traders are betting shares of the stock will rise by 8% by the middle of May. The shares have outperformed the broader S&P 500 and the Financial Select Sector SPDR ETF (XLF) in 2018, with BAC up by nearly 2%, versus a decline of roughly 1% for the S&P 500 and 1.5% for XLF.
The bank is expected to report that first-quarter 2018 earnings climbed by nearly 44% from a year ago to $0.59 per share, while revenue is expected to jump by only 2.8% to $23.08 billion. But with traders betting on the stock's rise after results, it implies some investors are looking for the quarterly results to top those expectations.
Option Pricing In Modest Volatility
The long straddle options strategy set to expire May 18 is pricing in a rise or fall for the stock of nearly 7.2% from the $30 strike price. It gives the stock a modest trading range between $27.85 and $32.16. The number of open calls and puts at the $30 strike price are reasonably even with 34,000 open call contracts and 38,000 open put contracts, indicating a sufficiently neutral viewpoint. But the open interest soars when looking further down the option chains.
An 8% Rise
The call options at the $31 strike price contracts have an open interest of 51,000 contracts, while the $32 strike price contacts have an open interest of 100,000 contracts, and together the two options have a notional value of $7 million. For the options at the $32 strike price to make a profit, the value of the stock would need to rise to roughly $32.40, with the options trading for approximately $0.40 per contract. It would mean shares of Bank of America's stock would need to rise 8% from its current price around $30.
Bets Have Been Growing
The number of open call contracts for the $31 and $32 strike prices has more than doubled in recent weeks. The $31 strike price contracts have seen their open interest climb from roughly 18,500 contracts to 51,000 contracts. The number of open contracts at the $32 strike price has climbed from 50,000 contracts to 100,000 contracts. The large bets going to earnings suggest that traders are looking for shares to rise after the results are released.
The bullishness comes during a period of increased volatility for the broader market, which means any disappointment in those earnings could lead to shares falling sharply, and the bullish bets for profit quickly turn to losses.
Michael Kramer is the founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past 12 months. Past performance is not indicative of future performance.