American Express is highly rated and is above rising 21-, 50- and 200-day moving averages.
Earnings are set for July 19, and today let's look at a strategy called a pre-earnings diagonal call spread.
Investors who think American Express stock will continue to rally could use options to gain exposure while reducing risk.
Let's take a look at how we can use options to find a favorable risk-to-reward trade. This is with the assumption that the stock might move toward 245 in the next few weeks. That would put it at new highs.
We'll look at a bullish diagonal spread. It allows traders to get long on the stock without risking too much capital.
A bullish diagonal spread is a trade that involves buying a long-term call option and selling a shorter-term, out-of-the-money call option against it.
Buying the Dec. 20, 230-strike call will cost around $2,300 and selling the July 26, 245-strike call option will generate around $360 in premium.
Max Profit About $750
That results in a net cost for the trade of $1,940 per spread, which is the most the trade can lose.
The estimated maximum profit is estimated at around $750, but that can vary depending on changes in implied volatility. The maximum profit would occur if American Express closed right at 245 on July 26. That would represent a return of around 39%.
The idea with the trade is that if the stock trades up to around 245, the diagonal spread will increase, resulting in a net profit.
A bullish diagonal spread is a good way to gain some upside exposure on a stock without risking too much if the move doesn't eventuate.
Trade About Equal To Owning 30 Shares
The combined position has a net delta of 30. That means the trade is roughly equivalent to owning 30 shares of American Express. But this will change as the trade progresses.
The suggested stop loss level is a close below 225.
According to the IBD Stock Checkup, American Express is ranked No. 2 in its industry group and has a Composite Rating of 91, an EPS Rating of 93 and a Relative Strength Rating of 91.
This trade would have earnings risk if held to expiration.
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 X/Twitter at @OptiontradinIQ
