Arista Networks saw a massive bounce Tuesday as the company topped analysts' estimates.
Earnings jumped 46% to $1.83 per share and revenue rose 28% to $1.51 billion. Tuesday's 14% stock price gain saw ANET stock rise above a 198.46 buy point.
Investors who think Arista 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 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, depending how the trade goes.)
ANET Stock Call Option Benefits
Assuming an investor wanted to buy 100 shares of ANET stock, he or she would have to invest around $20,000 at the current share price.
Instead, the investor could gain a similar exposure using a fraction of the capital by buying a call option. One call option gives the investor exposure to 100 shares.
If an investor were to buy one Arista 190-strike call option expiring on June 21 next year, he or she would need to invest only around $3,460 rather than $20,000. (Those call options were quoted at $34.60 late Tuesday.)
The break-even price for this call option is equal to the strike price plus the premium paid, which would make the break-even 224.60.
The most the trade can lose is the premium paid of $3,460, which would occur if ANET stock finished below 190 on June 21.
Trade Has Unlimited Upside
However, if Arista 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.
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 June 21, 250-strike call would reduce the trade cost by around $1,215. But it would also limit the upside above 250.
A stop loss could be set if ANET drops 8% from the entry point.
According to the IBD Stock Checkup, ANET stock is ranked No. 1 in its industry group by EPS Rating, which is 98. Its Relative Strength Rating is 96 and the Composite Rating is 99.
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 Twitter at @OptiontradinIQ
