IBM is one stock that I think has limited upside, even if the stock market experiences a bounce this week. Today, we're going to look at how to set up a bearish option income trade, called a bear call spread.
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.
On Friday, an IBM bear call spread using the August expiry and the 150-155 strike prices was trading around $0.70.
This week, I'll be looking to sell that spread if it rises to around $1.10.
Maximum Profit $110 Per Contract
If executed at that price, the maximum profit on the trade would be $110 per contract with a maximum risk of $390.
The spread will achieve the maximum profit if IBM stock closes below 150 on Aug. 19, in which case the entire spread would expire worthless, allowing the trader to keep the $110 option premium.
The maximum loss will occur if IBM closes above 155 on Aug. 19, which would see the premium seller lose $390 on the trade.
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.
A stop loss could be set if IBM trades above 145, or if the spread value rises from $1.10 to $2.20.
Not A Smart Trade For Those Bullish On IBM Stock
Because this is a bearish position, traders who think IBM stock could move higher from here should not enter this trade.
According to the IBD Stock Checkup, IBM stock is ranked No. 7 in its industry group and has a Composite Rating of 91, an EPS Rating of 73 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
