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Morning Update

Ahead of the US open global risk sentiment appears strong. Asian stock indices were up, led by the Nikkei (+2.39%) on reports that LDP and its coalition will pass a new US $119B stimulus package to spur on the Japanese economy. News out of Germany was also positive this morning, with IFO business confidence rising month/month. Housing data in the US was positive this morning, lead by strong gains in the South that made up for weakness in the northeast. The fiscal cliff will continue to have the most sway over US markets. The House is expected to pass Boehner’s “Plan B” as early as tomorrow despite Reid’s statement that it will not pass the Senate. This is seen as a way for Republicans to shift blame for going off the cliff onto the Democrats. After strong gains the past few days I would not be surprised to see some profit taking today or tomorrow unless real progress on a deal is announced.

This week the Dow has put in back to back triple digit gains, led by Bank of America. This stock has already doubled this year, and option traders are betting on continued momentum. Yesterday BAC was up over 3% and the call-put ratio was 3.2:1 on heavy option volume. One trader bought 4531 Jan. 12.5 calls for $0.09 with the stock at 11.22. This is a bullish bet that will profit if BAC is above 12.59, 12% higher, at January expiration in 30 days.

This bullishness comes on expectations of a resolution to the fiscal cliff and that BAC will breeze through the next round of government stress tests. If the stock passes the stress tests it will be allowed to raise its dividend from the $0.04 it currently pays. Meredith Whitney thinks the company could pay out as much as $18 billion, which would be a payout of about $1.60/share. Bank of America currently has $9.87 in cash per share and trades at 0.6 times book value. BAC also has a better debt-to-equity ratio than both JPM and C, making it relatively attractive in the banking sector. The only troubling aspect of BAC is that its EPS and revenue have been in decline on a year of over year basis. This has been in line with analyst expectations, but a trend I would like to see reverse.

Because BAC has risen so much in 2012 I would rather buy calls on the stock than own in outright now. Bank of America will report earnings on Jan. 17th, which will be just before January options expiration. Call options also remove a lot of the risk of holding stocks through the fiscal cliff negotiations and will minimize losses if we go off the cliff. If there is a solution to the fiscal cliff BAC is likely to continue its rally into earnings, which, if good will add more fuel to the rally. The stock’s book value is currently $22.14 and on expectations of a large dividend payout the stock could rally there or even higher. Buying Jan. options will be a play on BAC’s upcoming earnings. If the options are in the money I would exercise them and buy the stock to hold through March.

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