Vertex Pharmaceuticals[ticker symb=VRTX] was Friday's IBD Stock of The Day, closing up 1.3% when the rest of the market was generally weak.
VRTX stock recently bounced off the all-important 50-day moving average and a new flat base is forming on the weekly chart.
Let's look at how we can use options to find a favorable risk to reward trade on the assumption that Vertex stock might move 5%-10% higher in the next month.
We will look at a bullish diagonal spread, which allows traders to get long VRTX 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, further out-of-the-money call option.
Traders with a price target of 260 could place the bullish diagonal spread at that price.
Selling the April expiry, 250-strike call option will generate around $550 in premium. Buying the July 250-strike call will cost around $1,550.
Maximum Loss $1,000 On Trade
That results in a net cost for the trade of $1,000 per spread, which is the most the trade can lose.
The estimated maximum profit is around $1,200, but that can vary depending on changes in implied volatility. The maximum profit would occur if Vertex stock closes right at 250 on April 14.
The idea with the trade is that if Vertex stock trades up to around 260, 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.
Equivalent To Owning 20 VRTX Shares
The combined position has a net delta of 20. That means the trade is roughly equivalent to owning 20 shares of Vertex stock. But this will change as the trade progresses.
The suggested stop loss level is a close below 225.
VRTX stock is ranked No, 2 in its group and has a Composite Rating of 95, an EPS Rating of 98 and a Relative Strength Rating of 91.
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
