Monday, October 3, 2011

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

BAC is trading $5.64, down 7.9% with IV30™ up 22.3%. The LIVEVOL® Pro Summary is below.

I last wrote about BAC on 8-8-2011 and caught a bit of an s* storm for it. You can read that apparently provocative post here:
Bank of America (BAC) - The Odds of the Largest Bankruptcy... Ever...

BAC was trading $6.52 at the time with IV30™ at 151.75. Here's a snippet of the article:

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.


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

Sort of echoing the sentiment from the last post about BAC, that stock chart simply looks like a company that has a non-trivial chance of bankruptcy. The vol may not reach the prior highs, but one more reputable story about what the "catastrophic news" could be, and I'm betting we could see 200+ vol in BAC.

Looking to the Skew Tab, below we see a frighteningly normal skew.

Why frightening? Because no one is offering those crazy baby puts and pounding the vol. This is BAC ppl! I mean, the largest bank can't wipe out their shareholders, right? Wait?... What's the full name of this company? Bank of America Merrill Lynch Countrywide... What does the Countrywide part mean? For that matter, what does the Merrill Lynch part mean?

Finally, let's turn to the Options Tab and put some numbers to it.

We can see the Nov 2 puts are priced to ~ $0.065 fair value. Not shown here, but in the later months, the Jan 2013 1 puts are worth ~$0.165. Said simply, the option markets reflect ~16% probability that BAC goes bankrupt within 15 months. Yeah... a 1/6 chance. Using the Feb 2 puts, the option market reflects ~4% chance of bankruptcy within the next five months.

Keep in mind, both Countrywide and likely Merrill Lynch were going to suffocate and eliminate all shareholder value from a bankruptcy.  That risk didn't go away, it got swallowed up by BAC.  Take 2x bankruptcy risk within a firm which now faces its own potential risks.  Yeah... This is real.

However you slice it, there is one reality reflected by the option market, no matter how much you pound the table and say it can't happen.

Bottom line: There is a low, but non-trivial possibility that the stock of what once was the largest bank in the United States, simply goes away.

This is trade analysis, not a recommendation.

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