Three Ways to Profit from Your Bank of America (BAC) Warrants

So, it was either play the newest update on Fortnite all day, add additional content for my premium subscribers (don’t worry guys, doing that next) or write a post on Bank of America warrants. Since I stink at Fortnite anyhow…here we go.

I’ve been asked by a few investors who hold BAC warrants what I would do with them given the upcoming expirations in October (the B warrants) and January (the A warrants).

In addition to the information here, I’ve built a very simple Excel sheet so that you can track your warrant position profit and loss. You can get that at the end of this post.

Here are a few ways to play the warrants from here forward.

Sell the warrants now
Sell weekly calls against the warrants
Hold the warrants for possible further gains

1. Sell Your BAC Warrants

If you bought the warrants a year or more ago, and you have a +200% gain, don’t be a greedy bastard, sell Mortimer, sell. This isn’t your cryptocurrency account!

Seriously, if I had a gain like that in a bank warrant, and I was not arbing against that position, but just holding it, AND it had moved from way out of the money to in the money, I would have already sold some of my position into the rising price, and would sell more if the price keeps rising. (As always, each of you has tax consequences to consider, etc. which I am not addressing here.)

But wait you say, if I had read this a few months ago I would not have made every penny I possibly could because I would have gotten off of a winning horse. You are correct sir / ma’am. It’s just what I do with a winning position because that is my risk profile.

Again, if I’m not using it as part of an arbitrage position, but just holding long, I generally sell pieces of a winning position as it rises.

So, to summarize the first option, if your investment / trading profile is similar to mine, congratulations, you’ve made some nice money in your warrants!

But, if you are still holding and want to hold on to that position to capture what you think will be additional gains this year, make sure you read the third possibility of just holding the warrant below.

2. Trade Call Options Against Your Warrants

Needless to say, this is my preferred way to make money with warrants.

There are many variations here, but I’ll give an example and you can play with the numbers yourself, and look at other option strikes that may suit your style better.

This strategy works with both the A and B warrants, but I’ll focus mainly on the B warrants here as the profit potential on a percentage basis is higher. And, if I were going to purchase one of the warrants right now and implement this strategy it would be the B warrants.

First, let’s set the field we’ll be working on:

BAC stock price at time of writing, around $32.00
BAC class B warrant, exercisable at $30.79, and expiring October 28, 2018 (One warrant + $30.79 gives you 1 share of BAC common)
BAC class A warrant, exercisable at 12.757 as of 12/01/17, this strike changes as BAC pays dividends, so you’ll need to track this if you implement this strategy on an ongoing basis, and expiring January 16, 2019 (One warrant + 12.757 gives you 1 share of BAC common, plus an adjustment which you can read the footnote about on the BAC page linked to here, but which minutia I will not dive into in this post as it doesn’t impact this strategy) (You can also find a nifty little article posted here on Seeking Alpha which lays out the dividend impact on the warrants over time, which was written when the stock was much lower, but which is mathematically still correct.)

Finally, my quick analysis of the stock chart. In a word: nice. The stock broke out on 1/11, formed a short base and broke out again. Directionally it’s clearly moving up, but I wouldn’t be surprised to see another base forming around here. (FYI, I have not done any fundamental analysis of BAC for this post, and have no opinion on the business from that standpoint.)

For my purposes, the direction I believe the stock is headed colors the amount of hedge I employ, which I’ll get into here.

PRO TIP: Determining direction always brings to mind one of the simplest, and best, pieces of advice I ever received as a hedge fund trader. Me: “What do you think I should do with this position?” My boss: “Where do you think the stock is headed” Me: “Down.” My boss: “So I’d sell it.”

Given all of the above, with BAC trading right around $32, this would be my initial trade if I had, for example, 1,000 of the B warrants. I would sell 3 of the February 2, $32 strike calls at $.37 and 3 of the February 9 $32 strike calls at $.50. This would give me a partial hedge on the warrants, but still allow for the stock to move up. (Prices are approximate as they are constantly changing).

My goal would be to repurchase the calls as we get closer to their expirations, and maintain my warrant position. Then I would resell additional weekly calls each week, against the warrant position.

Not super exciting, but I believe you can grind out at least 10% per month in additional gains from the warrants over the next several months using this strategy.

3. Hold the Warrant for Further Gains

If you believe BAC will continue to move up this year, and you are holding the warrants as an investment that you intend to sell or convert to common stock at or near expiration, you should be aware of the following information.

If you’re familiar with option pricing and how options behave as their expiration date draws closer then you’ve got a pretty good idea of how the BAC warrants will react over the next 9 months to a year when the B and A warrants expire.

Class A Warrants

Currently the B warrants, which are slightly in the money, offer a great deal of leverage (the ability to control more stock with less money) than the A warrants, which are now deep in the money.

While the A warrants are trading at a higher price, due to their intrinsic value, the premium is smaller than that on the B warrants. Essentially buying the A warrants at this point is about the same as buying the stock.

The slight premium the A warrants have right now will dissipate as the expiration date draws closer so that by the last month before the expiration, assuming the stock stays around where it is or moves up, the warrant and stock will trade at parity.

If the stock continues to move up there should be a higher percentage gain on the warrants (since it’s rising off of a lower base price), an advantage to holding the warrants versus the common (and one reason there is a premium on the warrants still, they still give some leverage even this deep in the money).

This also means that if BAC moves down, the A warrants would move down also, duh (ignoring a spike in volatility scenario). AND, if the stock does not move at all from here until expiration, the warrants would move down in price as the current premium is reduced to nothing at expiration.

Class B Warrants

Like the A warrants, if BAC does not move in price the premium in the warrant will eventually disappear to trade at parity at expiration. And, if the stock moves up, the warrant will trade up as well, with the premium reducing as the warrant moves deeper in the money.

So, you’ll get more of a percentage gain with the B warrants, but it will not move up penny-for-penny with the common (again, barring a spike in volatility).

As you saw above, if I were going to enter a position in a BAC warrant at this time, it would be in the B warrants, and I would be selling weekly calls against that position.

What’s your take? Are you long warrants and holding for a higher move, or are you hedging your long position here? Let me know in the comments.

Finally, I’ve put together a very simple Excel sheet in which you can track your warrant and option buys and sells. Just fill out the form below to get access to it.

Post Script

February 2, 2018. That was the end of the original post, but I had a question on what the class B warrant premium decay might look like over the next 9 months, so I’m printing my reply here. If you’re trading calls against the B warrants you’ll want to know this, if not, get back to Fortnite.

The best way to figure out about what the premium curve will look like over the next several months is to look at call options with a similar strike between here and October.

So, right now the April 31 call options are trading at about 2.07, with about a $.94 premium, and they are about 3 months until expiration.

The August 31 call options are trading at around $3.05, or about a $2 premium, and they are about 7 months until expiration.

The warrants, are about 9 months out and have a $2.24 premium.

So, barring any crazy volatility in the stock, two months from now (meaning they will have 7 months to go until expiration) the warrants should still trade at about a $2 premium (similar to the current August 31 strike calls).

By the beginning of August the premium on the warrants will have dropped to around $1 (similar to the April 31 strike calls right now).

If you can picture a curve it will have a very gradual left to right slope from now until about 60 days before the warrants expire.

And then it will start to steepen. The last 30 days before the warrants expire it will get even steeper, until by the expiration date the warrants will trade at parity (assuming they are still in the money) with the stock.

This is why selling close in time calls against the warrants works well. Because the close in time calls, like next week and the week after, have very steep decay curves, meaning the premiums will quickly evaporate (in an instrument you are short) while the warrant premium will stay essentially the same (in an instrument you are long).

Barring the stock falling rapidly, and taking the warrant down with it, I can generally make 10% a month in a warrant / stock / option play like this (price, volatility, etc.) with below average risk, by selling calls against the warrant.