Monday, August 8, 2011

Bank of America (BAC) - The Odds of the Largest Bankruptcy... Ever...

BAC is trading $6.52, down 20.2% with IV30™ up 81.3%. The LIVEVOL® Pro Summary is below.

Obviously the vol (and stock movement) caught my attention. The news that's driving the company (other than the systematic risk) surrounds a lawsuit filed by AIG. Here's a quick snippet:

AIG is planning to sue Bank of America to recover more than $10 billion in losses on $28 billion of investment in mortgage-backed securities.

Meanwhile, widely-followed hedge fund manager David Tepper of Appaloosa Management said he is selling out his BofA and Wells Fargo stakes and decreasing his position on Citigroup.
Dow Falls 300, BofA Sinks 15%; Gold Soars, by JeeYeon Park (

So there you go. BAC is interesting in that if I look at it and am totally agnostic to the company, the vol and stock movement look like a bankruptcy stock. Of course, considering it's the largest bank in the world (or whatever), all of a sudden I feel ridiculous saying that. Let's take a look at some data.

The BAC Charts Tab is included (below). The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20 - blue vs HV180 - pink).

Let's start with the stock price (upper portion). BAC opened at $10.04. Today, as of this writing, BAC is trading $6.52, or down 35.2% in a week. We can also see the stock trend. As of 6 months ago (2-8-2011) the stock closed at $14.61 -- it's down 55.4% since then.

On the vol side (lower section), we can see the IV30™ was 40.94. As of this writing, the IV30™ is 151.75, or up 271% in a week. This type of stock and vol movement is symptomatic of companies in the early stages of bankruptcy risk. Not sayin'... just sayin'... There's more to come...

Let's look to the Skew Tab, below.

I've included the front four expirations (one weekly and three monthlies). The skew shape is quite normal looking and consistent across the months. We can also see a monotonic decrease in vol as we move into further out expirations.

Let's look to the Options Tab (below).

Here's where it gets quite interesting. In the options world, a very rough estimate of a company's bankruptcy risk is to take the lowest strike puts (as long as they are below $5 in strike), and calc the MaxGain (in % terms). Subtract that number from one, and that gives you a bankruptcy probability (sort of).

Let's do this test for BAC. The Aug (monthly) 2.5 puts are priced at ~ $0.10. That means the probability of bankruptcy in the next few weeks, using this massively flawed approach, is ~4%. Using this same methodology for the Jan'12 2.5 puts, that probability rises to ~14%... or, in English, back of the envelope calculation results in the option market's reflection that there is ~ 1/7 chance BofA goes away by Jan of next year. Yeah... those are just the numbers, no assessment of "practicality." But that's still a crazy number...

Just another side note -- what were the odds that Countrywide went bankrupt?  Are those the same for BofA now that the entities have merged?... Hmm...

This is trade analysis, not a recommendation.

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