Home Depot quietly broke out above resistance on Friday with the stock closing 1.26% higher, which resulted in a new 52-week high.
Investors who think Home Depot stock will continue to rally and don't want to risk significant capital can use long call options rather than buy the stock outright. This can be a good way to protect precious capital in these volatile markets.
A call option is a contract between a buyer and seller. The contract gives the buyer the right to purchase a certain stock at a certain price (strike price) up until a certain date (expiration date).
One of the benefits of call options is that they provide leverage. This can be both a good and a bad thing.
Assuming an investor wants to buy 100 shares of HD stock, he or she would have to invest around $36,200 at the current price.
Instead, the investor could gain a similar exposure using a fraction of the capital by buying a call option.
Call Options Provide Leverage
One call option gives the investor exposure to 100 shares.
If investors were to buy one HD 360-strike call option expiring on Feb. 16, they would only need to invest around $910 rather than $36,200.
The break-even price for this call option is equal to the strike price plus the premium paid, which would make the break-even price 369.10.
The most the trade can lose is the premium paid of $910, which would occur if Home Depot stock finished below 360 on Feb. 16.
However, if HD shoots higher, the upside is unlimited.
Using options in this way can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
Trade Can Be Converted To A Spread
Savvy traders can further reduce the risk by selling an out-of-the-money call, turning the trade into a bull call spread.
For example, selling the Feb. 16, 370-strike call would reduce the trade cost by around $410. But it would also limit the upside above 370.
A stop loss could be set if Home Depot stock drops 8% from the entry point.
According to the IBD Stock Checkup, Home Depot stock is ranked No. 2 in its industry group. It has a Composite Rating of 86, an EPS Rating of 75 and a Relative Strength Rating of 84.
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
