Buy Call Option on Bank of America Stock

Bank of America’s stock price has declined sharply recently – 10% over the past five days. The company released quarterly earnings that fell short of expectations and the selling pressure intensified. We think the stock price has now stabilized at support levels that have been established over the past six months. Despite the troubles in the financial sector, Bank of America is an excellent franchise, one that will weather the storm. In fact, we think the much maligned Merrill purchase will return exceptional results over the long term. The new CEO may not be the most dynamic of leaders, particularly on the acquisition front, but that is not what is needed now. The leadership emphasis should be execution over what they now have and we think Moynihan can provide that. This is a very well run bank that will bounce back with a vengeance!

How is the best way to play the turnaround? Investors could buy the Bank of America stock outright or buy a call option. We found a great buy on an “at the money call” with an exercise price of $15 that doesn’t expire for one whole year (VBAAC). Expiration is not until January 2011 and you can buy the call now between $2.50 and $2.60. Option buyers would have a whole year to wait for price appreciation and we think the underlying stock will take off by the second half of the year. If the stock moves in the right direction, the potential returns on the option could be huge and much larger than the return from owning the stock outright. The option cost has a breakeven that is only 17% above the current stock price and that represents a very low premium for this stock option having a full year until expiration. Investors could also buy the stock, but the option play has the potential for bigger returns over a smaller capital outlay.