Alphabet stock quietly broke out to an all-time high yesterday, closing up 3%. Today, Google stock is down but it's an inside day that's retaining the majority of Monday's gains. Investors who think the Alphabet stock will continue to rally could do so in a reduced risk way, with the use of options. The strategy we'll use today is a bullish diagonal spread. It's a little more advanced because it uses different expiration dates.
Setting Up A Bullish Diagonal Spread
A bullish diagonal spread is a trade that involves buying a call option and selling a shorter-term, out-of-the-money call option against it. Selling the shorter-term call brings in some premium to offset the cost of the long call.
Let's take a look at how we can use options to find a favorable risk-to-reward trade on the assumption that GOOGL stock might move toward 165 in the next six weeks.
The bullish diagonal spread allows traders to get long Google without risking too much capital.
We'll start with buying an Aug. 16 call with a 145 strike. That traded around 17.55 this morning so one contract would cost around $1,755. Then we'll sell the 165-strike call with a closer expiration at May 17. That option was bringing in around $320 in premium.
That results in a net cost for the trade of $1,435 per spread. This is also the most the trade can lose.
Making The Google Stock Trade Work
The maximum profit occurs if Google stock closes right at 165 on the May 17 expiration. The sold call would expire worthless in that case and you would still have a lot of time left on the long call with 20 points of cushion above the strike. That would lead to an estimated $970 in profit, but that can vary depending on changes in implied volatility.
The idea with the trade is that if GOOGL stock trades up to around 165, 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.
Risks And Stops For The Trade
According to IBD Stock Checkup, Google stock ranked No. 3 in its group and has a Composite Rating of 94, an EPS Rating of 98 and a Relative Strength Rating of 84.
The combined position has a net delta of 38, which means the trade is roughly equivalent to owning 38 shares of GOOGL stock, although this will change as the trade progresses.
The suggested stop loss level is a close below 146.
Alphabet is due to report earnings in the week of April 26, so this trade would have earnings risk if held to expiration.
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
