Eli Lilly is a highly rated stock that has had a solid run and could be due for a pause here.
Eli Lilly stock is above upward sloping 21-, 50- and 200-day moving averages. However, after an impressive run, I'm thinking it might pause around this level.
A calendar spread is an income trade that involves selling a short-term option and buying a longer-term option with the same strike price.
Usually, this is done with monthly options, but it can also be done with weekly options.
Traders typically use call options unless the trade has a bearish bias. In that case they would use puts.
In today's example, we'll look at a calendar spread trade on Eli Lilly stock.
How The Trade Works Best
With Eli Lilly trading around 954, setting up a calendar spread at 950 gives the trade a neutral outlook.
Selling the Sept. 20 put option with a strike price of 950 will generate around $2,175 in premium, and buying the Oct. 18, 950 put will cost approximately $3,235.
That results in a net cost for the trade of $1,060 per spread, and that is the most the trade can lose.
The estimated maximum profit is $1,650, but that could vary depending on changes in implied volatility.
The idea with the trade is that if Eli Lilly stock remains around 950 for the next few weeks, the sold option will decay faster than the bought option. That would allow the trade to be closed for a profit.
The break-even prices for the trade are estimated at around 910 and 1,000, but these can also change slightly depending on changes in implied volatility.
For this reason, calendar spreads are considered a more advanced strategy and not recommended for beginners.
Exit Strategy For Lilly Trade
For a trade like this, I would set a profit target of 30%, and I would set a stop loss if Eli Lilly stock breaks through either 910 or 1,000.
Eli Lilly has already reported earnings, so there should be no earnings risk with this trade.
Calendar spreads are a neutral option trading strategy. Bullish traders might consider something simpler like a bull call spread, such as Monday's example on Trade Desk.
Lilly is ranked No. 1 in its industry group and has a Composite Rating of 99, and EPS Rating of 93 and a Relative Strength Rating of 93.
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 X/Twitter at @OptiontradinIQ
