Datadog looks like a potential bearish candidate after breaking below the 50-day moving average Tuesday.
The 21-day exponential moving average is declining and sitting around 150, which could provide some short-term resistance.
With the stock under pressure, I'm willing to bet that it will trade sideways at best over the next few weeks.
Today, I'm looking at a bear call spread that assumes Datadog will struggle to get above the 150 level between now and the end of January.
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.
The strategy can be profitable if the stock trades lower, sideways, and even if it trades slightly higher, as long as it stays below the short call at expiry.
Setting Up Trade On Datadog Stock
A Jan. 31 expiry bear call spread on Datadog using the 150-155 strike prices can be sold for around $1.25, based on late-Tuesday quotes.
Traders selling the spread would receive $125 in option premium, which is also the maximum possible gain. The maximum loss would be $375.
That represents a potential return of 33% between now and Jan. 31.
The spread will achieve the maximum profit if Datadog closes below 150 on Jan. 31. In this case, the entire spread would expire worthless, allowing the trader to keep the $125 option premium.
The maximum loss will occur if Datadog closes above 155 on Jan. 31, which would see the premium seller lose $375 on the trade.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy. That means you always know the worst-case scenario in advance.
Managing Datadog Stock Trade
A stop loss could be set if Datadog trades above 148, or if the spread value rises from $1.25 to $2.50.
Because this is a bearish position, traders who think Datadog could move higher from here should not enter this trade. The position starts with a delta of -11, meaning it is roughly equivalent to being short 11 shares of Datadog.
A bear call spread can also act as a small hedge for long stock holders.
According to the IBD Stock Checkup, Datadog is ranked No. 9 in its industry group. It has a Composite Rating of 98, an EPS Rating of 94 and a Relative Strength Rating of 82.
The last bear call spread we looked at on Palantir Dec. 31 is looking good so far with the stock down 8%.
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 X/Twitter at @OptiontradinIQ
