With soaring inflation, the stock market has already priced in significant rate hikes. While this should tamper prices, it will likely come at a cost to growth. Many tech stocks may continue to suffer. And that could include leading growth stocks such as Broadcom.
So, for investors who want to bet on a large rally in a name such as Broadcom stock but want to be safe against downside risk, a long call option can work remarkably well.
Long On Calls: A Low Risk, High Reward Trade
While a long call option sounds risky, it is actually a low risk trade. Why? Only the premium from the contract potentially gets lost. The important caveat here: the trader only buys a small number of contracts, to which they are comfortable with the maximum loss.
For investors thinking the economy could experience unexpected strength, they can consider buying a June 680 call option on Broadcom stock.
This call option currently costs $6.00, and that equates to a maximum loss of $600. Due to the fact that this option currently trades out of the money — having a delta of only 17 — this option will expire worthless if the stock trades below 680 on expiration. However, a strong rally in Broadcom stock can multiply an investment several times over — even before the contract is in the money.
Conversely, if the market crashes, the investor losses the call premium. But he or she also avoids massive losses from being long on the shares or by having sold put options short. This can make a call option appealing in the event an investor worries about the potential for substantial market drawdowns.
As this option is out of the money, watch the volatility.
Even if shares increase in price at a slow rate the contract can decline in value. Broadcom's June options are currently trading at an implied volatility of 32%, which seems fair considering the stock has realized 33% over the past month. Broadcom stock will also report earnings in early June, which should be an extra source of volatility.
Broadcom Stock: Ranking High Among Chip Stocks
Earnings growth is expected to continue for the company. After reporting earnings of $28.01 in 2021, EPS is projected to increase to $35.52 this year.
Broadcom is outperforming its chip peers and ranks first in IBD's Electric Semiconductor group, according to IBD Stock Checkup.
Shares are forming a 3-1/2-month cup with handle and show a buy point of 645.41. The depth of the base, at 24%, falls within normal range following AVGO's prior run.
