Morgan Stanley has been trading within a narrow range for the last month or so. That could mean it's a good time to look at a long strangle trade for a potential breakout from the range.
A long strangle is constructed by buying an out-of-the-money call and an out-of-the-money put.
The trade aims to make a profit from a big move in either direction by the underlying stock.
Buying a long strangle is cheaper than a buying a long straddle, but will still suffer from time decay. That means the options will lose a little bit of value with each day that passes if the stock doesn't make a big move.
Time Factor In MS Stock Trade
With a long strangle, the further out in time the trade is placed, the slower the time decay. But the options are more expensive and require more capital.
For MS stock, a long strangle could be placed by buying a 90 strike call and an 82.50 strike put for the June 21 expiration. The call was trading around $2.90 late Wednesday and the put around $3.15.
When we add the two together, the total cost of the trade would be around $6.05 per contract, or $605. This is the total amount of risk in the trade, and the maximum that could be lost.
The break-even prices are calculated by taking the strike price plus and minus the cost of the strangle.
That gives us break-even prices of 76.45 and 96.05. But profits can be made with a smaller move if the move comes earlier in the trade.
For example, the estimated break-even prices at the end of March are around 80 and 91.
Implied Volatility Could Affect MS Stock Trade
Changes to implied volatility will have a big impact on this trade and the interim break-even prices. So it's important to have a solid understanding of volatility before placing a trade like this.
The ideal scenario is a large move in either direction within the first week or two of the trade.
The worst-case scenario with this MS stock long strangle would be a stable stock price, which would see both the call and put slowly lose value each day. For a long strangle, I usually set a stop loss at around 20% of capital at risk, which would be around $120. The profit target is around 40%.
I also wouldn't hold the trade any longer than March 31.
According to the IBD Stock Checkup, MS stock is ranked No. 13 in its industry group. It has a Composite Rating of 62, an EPS Rating of 46 and a Relative Strength Rating of 48.
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 X/Twitter at @OptiontradinIQ
