We may not have the same bankroll as Warren Buffett but we can accomplish the same results with a little different strategy.
I wrote on Wednesday night I thought there was too much risk to launch any bullish put selling plays. With the Dow trading in a 300 point range today and ending down -170 I am glad I passed on the opportunity. However, despite the volatility there are plays we can make that can produce monster rewards with minimal risk. They are a few and they don't come along very often but they do exist.
You may have heard about Warren Buffett investing $5 billion in Bank of America. That is not only a bet on BAC but also a bet on the U.S. economy. Berkshire now has $5 billion on the line in hopes the economy improves and Bank America will lead the charge out of the current financial soft patch. Granted they have some problems still to overcome but they have more than $1 trillion in deposits and amazing opportunities as the economy improves.
As part of the $5 billion investment Berkshire was awarded 700 million warrants to purchase the stock at $7.50 within the next ten years. Personally I believe that is a bargain deal. I believe BAC will be trading much higher years from now and will be the premier bank in America once they get the mortgage crisis behind them. If BAC returns to $15 and the same level it was trading in January those warrants will be worth $5.5 billion in profits.
While I can't promise you $5.5 billion in profits I do believe I can promise you $750 in profits for every contract you trade in the play below if BAC returns to that $15 level by January 2013 and the odds are pretty good they will hit that level. Not only will I promise you that $750 in profits with BAC at $15 I am going to show you how to do it for free.
I am not normally a promoter of individual stocks or individual trades. As we all know any trade can go south for a variety of reasons. However, on a scale of 1-10 I would put this trade at least an 8 or 9 but that is because I believe BAC is going to recover. The current BAC dilemma is directly related to the acquisition of Countrywide Financial at the request of the Federal Reserve. Countrywide was the largest producer of subprime mortgages and they were rapidly imploding. Henry Paulson and Ben Bernanke gave BAC special backing to take over Countrywide and keep them from taking down the entire mortgage sector. Ken Lewis, the BAC CEO at the time, realized there would be problems but thought they would be manageable. It cost him his job but BAC is managing through these problems. I have followed the scenario faithfully and despite the current suits BAC is not in danger.
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Current Position Changes
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BAC - Bank of America (Combination Play)
Warren Buffet got his 700 million in warrants to purchase BAC stock at $7.15 for free as a side benefit to his $5 billion investment. Free always works for me but I don't have $5 billion to buy preferred shares. Instead I am going to recommend we do a free play of our own for a lot less risk.
I am going to recommend we sell the Jan 2013 $7.50 put, currently $2.16 and buy the Jan 2013 $7.50 call, currently $2.36. If BAC dips at the open on Friday we can probably get even closer to a breakeven on the trade.
If BAC rallies to $15 by Jan-2013 we can sell our call for a $7.50 profit. However, if BAC ends below $7.50 in Jan 2013 then we will be forced to buy the stock at $7.50. As of today I donâ€™t' see that as a bad deal because I expect BAC shares to be in the $20-$30 range within the next five years.
If the trade goes as planned we can close our FREE calls in Jan 2013 and use the proceeds to buy even longer calls to capitalize on what I hope is an upward trajectory by then. Or, we can use the proceeds to buy oil stocks to capitalize on rising oil prices. What you do with your profits is up to you.
Let me be clear. There is no stop on this trade because I expect BAC to remain volatile. If it declines we may repeat the process at a lower level. This is a long term trade and we will target Jan 2013 as an exit. The risk is eventually owning BAC at $7.50 but until then we will have zero cost in the trade other than a little margin for initiating the position.
ANY close over $7.50 in Jan 2013 is a profit.
BUY BAC Jan-2013 $7.50 Call, currently $2.36, no stop, no target
SELL Short BAC Jan-2013 $7.50 Put, currently $2.16, no stop, no target
Chart of Bank America
New Aggressive Recommendations
There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.
Here is the most common margin calculation for naked puts.
100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))
For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)