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Morning Update

Yesterday call options on Bank of America were active on above average volume ahead of today’s bank stress test results. The biggest trade of the day was the purchase of 13427 March 12 calls for $0.20 with the stock at 11.85. This is a bullish bet that BAC will be above 12.20 (3% higher) on expiration next Friday. Bank of America is poised to pass the Federal Reserve’s stress tests with flying colors this time around, which could open the door to a possible dividend increase and stock buyback.

Currently Bank of America is the best capitalized of largest American banks with a Basel III Tier 1 common capital ratio of 9.25%. 5% is the minimum required, which leaves Bank of America with a comfortable amount of excess capital, some of which analysts expect could be allowed to be returned to shareholders. Analysts at JPMorgan estimate that Bank of America could increase its dividend from $0.01 to $0.04 and buy back up to $4 billion in stock. However, news about possible dividend increases will not come until next week.

This trade is a short term trade betting that Bank of America’s stress test results are better than expected and that the bank is then given permission to begin returning capital to shareholders. If expectations are not met the stock could sell off or simply stay put, which is why this trader chose to buy short dated calls instead of buying the stock. If BAC does increase its dividend and announce share buybacks these calls could easily expire in the month, in which case they would be exercised into a long stock position that could be held to collect the dividend and capture what could turn out to be a continuation of the long term rally in the financial sector.

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