It’s been underreported, but an important opportunity has emerged in Bank of America Corp (NYSE:BAC) options and the rest of the market may be missing it.
WHAT IS EDGE?
One of the great beauties of option trading is that the market prices the ‘greeks,’ which serve as a measure of probability.
If a trade wins more often than the probability that is priced in, it has edge.
Here is that same thought process, but in English: A 30 delta (out of the money) put should end up in-the-money about 30% of the time (delta is roughly a measure of probability). In other words, if we sold a 30 delta put, we would expect that we could have a winner 70% of the time.
EDGE
Now, back to our idea of edge. If we can find an option strategy that has a 30 delta, but if selling it wins more than 70% of the time, then we have edge. Even further, even if it wins ‘just’ 70% of the time, if the net profit is positive, then that’s another measure of edge.
Bank of America Corp (NYSE:BAC)
If we test selling a 30 delta put, every two-weeks in Bank of America Corp over the last 3-years, this is what we find:
This result is bad, but it gives us a window into how exactly to trade BAC options. We actually see a 84.6% win-rate, which is substantially superior to the 70% we expected. But, the returns are negative. Putting our detective hats on, what we are seeing here is that the few losing trades are having large negative returns.
Now that we have diagnosed the problem, we can address it. Let’s do this exact same strategy, but let’s avoid the risk of earnings. That is, we simply skip trading during earnings events. Here is the easy set-up — just a tap of the mouse:
And here are the results, now that earnings are avoided:
By taking less risk, we have turned a losing strategy into a winner, while maintaining a very high percentage of winning trades. But the real opportunity here is not what has happened 3-years ago, it’s the overwhelmingly bullish sentiment for banks that is happening right now.
This is how that same short put strategy, while avoiding the risk of earnings, has done over the last 6-months:
Over the last 6-months, there have been 12 two-week trading windows if we avoid earnings. Every single two-week period has produced a win with this short put, and the returns are over 50%. That is enormous edge and it’s growing as the market looks to a rate hike and possible deregulation.
Betting on a mega cap not going down has been very profitable, it can be adjusted to take less risk, and that risk reduced implementation has been even better.