Chevron stock has been on fire lately but is now quite overbought, with a relative strength index reading above 80.
With the stock looking a little extended here, Chevron might rally a little further, but possibly not much further.
In situations like this, I like to use a diagonal call spread. This is an advanced options strategy because it utilizes options over two different expiration periods.
The ideal scenario is that the stock rallies up to just below the short call right before expiry.
Selling the March 18 expiry, 165-strike call and buying the April 1, 170 call would generate a credit of around $0.45, or $45 per 100 share contract.
Because the trade can be placed for a credit, the worst that can happen on the downside is that both calls expire worthless and the trader keeps the $45 premium.
Profit Zone For Chevron Stock
The maximum risk on the upside is equal to the difference between the strikes less the premium received.
With the strikes being $5 apart, that makes the risk on the upside $455.
There is a nice profit zone between around 155 and 170, with a maximum potential profit estimated at around $310, but the catch is you don't want the stock to get to that zone too quickly.
In terms of risk management, I would set a stop loss if the stock rallies up above the short call at 165. As an example, if that were to happen today, the trade might be down around $100.
Chevron earnings are set for late April or May, so there is no earnings risk with this trade.
Option Strategy Not For Beginners
Diagonal spreads are an advanced strategy and not recommended for beginner options traders.
According to the IBD Stock Checkup, CVX stock is ranked No. 6 in its group and has a Composite Rating of 98, an EPS Rating of 71 and a Relative Strength Rating of 97.
It's important to 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
