I’m Back to Buy More Bank of America Corp Warrants

These derivative securities offer the best way to play B of A

Aug 7, 2014 at 12:28PM

Bank of America (NYSE:BAC) just announced that it had received official "non-objection" from the Federal Reserve to raise its dividend. The bank will notch up its quarterly payout from a penny a share to a nickel. It's the first dividend increase for the troubled bank since 2007. The move should create value for shareholders and warrantholders, and my Special Situations portfolio is biting off another chunk of the warrants for their huge leveraged upside.

Why warrants?
The warrants remain very attractive if you like Bank of America long term. They offered leveraged upside on the bank's common stock. As I noted in my original buy recommendation in April:

"The special situation here is the TARP warrants issued as part of the bailout of the financial system in 2008. Warrants can be particularly attractive, since long-term derivative securities tend to be mispriced, and I think that's what we have in Bank of America's January 2019 warrants with a strike price of $13.30."

So you have 4.5 years of time for these warrants to appreciate as the bank's legal troubles subside and the economy normalizes. And now with the dividend announcement we have a clear indication of more upside. As I explained in the original write-up:

"The warrants have another interesting feature, a so-called anti-dilution provision that, among other things, protects warrant holders if B of A pays dividends greater than $0.01 per quarter. In effect, warrant holders get to collect that dividend via a provision that lowers the effective strike price of the warrants."

The more that dividend increases, the lower our strike price for the warrants and the more they're worth. So further dividend increases in later years could really juice the return here. For more on the warrants, follow me on Twitter: @TMFRoyal. And check out my dedicated discussion board.

Yes, Bank of America had to cancel its previous $4 billion buyback, and that's not a good thing. But it's baby steps as the bank and the economy finally begin to normalize. A great way to invest in that return to normalcy is via the bank's warrants.

Foolish bottom line
So my Special Situations portfolio is buying more Bank of America warrants, adding another $500 to my position. I think 20%+ annual returns are a real possibility here.

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Jim Royal has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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