American Express dropped to test the 21-day moving average Wednesday and closed near the low of the day. If the stock continues to struggle, traders might consider a bearish trade known as a bear put spread.
A bear put spread is a debit spread, meaning that we need to pay the premium to open the trade.
On American Express stock, a bear put spread could be set up using the 140 strike as the long put and the 135 strike as the short put for the January expiration.
This trade would cost around $55 per contract with a maximum potential gain of $445. Placing the trade further out-of-the-money would create an even more favorable risk-to-reward scenario.
Trade Targets 12% Drop By Jan. 20
To achieve the maximum profit, this trade would need AXP stock to drop 12.4% between now and expiration on Jan. 20. American Express is trading around 154 after meeting resistance at its 200-day moving average.
The break-even point for the bear put spread is 139.45, which is calculated as 140 less the $0.55 option premium per contract.
If American Express drops early in the trade, it may be possible to make a profit at slightly higher prices.
At expiration, if the stock is trading above 140, the entire spread would expire worthless, and the trade would lose 100%, or $55.
No Stop Loss May Be Needed
For a trade like this, I wouldn't bother with a stop loss. Either the trade works or it doesn't, so I would trade an appropriate position size in case I suffered the full 100% loss. Alternatively, you could set a stop loss at 50% of the premium paid.
Because this is a bearish position, traders who think American Express stock could move higher from here should not enter this trade.
According to the IBD Stock Checkup, AXP stock is ranked No. 10 in its group and has a Composite Rating of 76, and EPS Rating of 70 and a Relative Strength Rating of 54.
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
