Applied Materials showed up in one of my bullish scans today after the stock bounced off the 21-day moving average. AMAT stock could be headed for a test of the early February high of 125.
The company reports earnings after today's close, and a positive surprise could get the stock to that level quickly. Of course, a disappointing report could knock down the stock. The stock pulled back to its 116.19 buy point last week and found support around that level. A cheap way to gain some upside exposure using options is via a bullish calendar spread.
Volatility is quite low at the moment, which is why I would favor a calendar spread over a credit spread.
A calendar spread is a trade that involves selling a short-term option and buying a longer-term option with the same strike price.
Calendar Spread Targets Prior High
With AMAT stock trading around 119, a bullish calendar spread might be placed at 125.
Selling the March 3, 125 call option will generate around $190 in premium and buying the March 17, 125 call will cost around $325.
That results in a net cost for the trade of $135 per spread, and that is the most the trade can lose.
The estimated maximum profit is around $285. But that could vary depending on changes in implied volatility.
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The idea with the trade is that if AMAT stock trades up to around 125, the calendar spread will increase in value, resulting in a net profit.
The break-even prices for the trade are around 117 and 134.
About The Same As Owning 25 Shares
The position starts with a delta of 25, meaning the exposure is roughly equivalent to being long 25 shares of AMAT stock. This will change as the trade progresses.
I would close this bullish calendar spread if Applied Materials rallied to 125, or if it dropped below 113.
According to the IBD Stock Checkup, Applied Materials is ranked No. 7 in its industry group and has a Composite Rating of 92, an EPS Rating of 80 and a Relative Strength Rating of 65.
It's important to remember that options are risky and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
