Arista Networks was Monday's IBD Stock Of The Day and recently broke out above a near-term high. A long call option can provide a way to participate in an upside move with less capital and a defined risk.
ANET Stock Leads Computer Networking Group
ANET stock is getting more attention after announcements of big spending by Facebook parent Meta Platforms. The Computer-Networking group climbed to No. 10 this week, according to MarketSmith.
The individual ratings on ANET stock aren't too shabby either. According to IBD Stock Checkup, ANET stock is ranked No. 1 in its group and has a Composite Rating of 99, an EPS Rating of 97 and a Relative Strength Rating of 86. It's earned a spot on both Leaderboard and SwingTrader.
Investors who think ANET stock will continue to rally and don't want to risk significant capital can use long call options rather than buy the stock outright. This can be a good way to protect precious capital in these volatile markets.
Call Options Provide Leverage With Limited Risk
A call option is a contract between a buyer and seller. The contract gives the buyer the right to purchase a certain stock at a certain price (strike price) up until a certain date (expiration date).
One of the benefits of call options is that they provide leverage (this can be both a good and a bad thing). But you know from the outset what the maximum loss is and it can be a lot less than owning the stock outright.
Assuming an investor wanted to buy 100 shares of ANET stock, they would have to invest around $13,200 at the current price.
Instead, the investor could gain similar exposure using a fraction of the capital by buying a call option. One call option gives the investor exposure to 100 shares. Say an investor buys one ANET 120 call option expiring on March 17 trading around 21.00. That only requires a $2,100 capital outlay rather than $13,200.
The break-even price for this call option is equal to the strike price plus the premium paid. That makes the break-even price 141.
If ANET stock finishes below 120 on March 17, the option expires worthless. That means you lose the entire premium paid of $2,100. But no matter how far down it goes, you won't lose more than the premium paid. Owning the stock technically has $13,200 at risk. Though investors would most likely cut losses short well before ANET stock went to 0, they could suffer much greater losses than $2,100.
On the positive side, if ANET stock shoots higher, the upside is unlimited.
Using options in this way can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
A Twist To The Long Call Option
Savvy traders can further reduce the risk by selling an out-of-the-money call, turning the trade into a bull call spread.
For example, selling the March 17, 150 call would reduce the trade cost by around $680. While having just $1,420 at risk is great, there is a catch. You also limit the upside above 150. If ANET Stock rockets past that, the bull call spread would cap your profit at $2,320.
A stop loss could be set if ANET stock drops 8% from the entry point.
Yesterday's bullish diagonal spread on Netflix is already looking good and can potentially be closed early.
Please 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
