With the market looking a little extended here, it might be a good idea to add a bearish trade to hedge some downside risks.
Spotify dropped just below the 50-day moving average Wednesday and could be a good candidate for a bearish trade.
Today, I'm looking at a bear call spread on Spotify stock.
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. It just needs to stay below the short call at expiry.
A September-expiry bear call spread on Spotify using the 380-390 strike prices can be sold for around $0.70.
Potential Return Of 7.5% On Spotify Trade
Traders selling the spread would receive $70 in option premium, which is also the maximum possible gain. The maximum loss would be $930.
That represents a potential return of 7.5% between now and mid-September.
The spread will achieve the maximum profit if Spotify stock closes below 380 on Sept. 20. In that case, the entire spread would expire worthless, allowing the trader to keep the $70 option premium.
The maximum loss will occur if Spotify stock closes above 390 on Sept. 20.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy, and you always know the worst-case scenario in advance.
Exit Strategy For Spotify Stock Trade
A stop loss could be set if Spotify trades above 260, or if the spread value rises from $0.70 to $1.40.
Because this is a bearish position, traders who think Spotify stock could move higher from here should not enter this trade. The position starts with a delta of -3, meaning it is roughly equivalent to being short three shares of Spotify.
According to the IBD Stock Checkup, Spotify stock is ranked No. 2 in its industry group. It has a Composite Rating of 84, an EPS Rating of 73 and a Relative Strength Rating of 95.
Spotify is due to report earnings around July 23, so this trade would have earnings risk if held to expiration.
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
