Amgen is pulling back following a strong few months and remains above a rising 50-day moving average. Bullish traders can take some upside exposure in Amgen stock via an option trade called a risk reversal.
Risk Reversal On Amgen Stock
Risk reversals are bullish trades that involve selling an out-of-the-money put and using the proceeds to purchase an out-of-the-money call.
On Amgen stock, this type of trade would only be appropriate for large traders as the maximum risk is around $26,500.
Let's take a look at how the risk reversal trade might look on Amgen stock.
Going out to the June 2023 expiration gives the trade plenty of time to work out. The June 265 put sold yesterday for around $13.60 per contract.
Those proceeds can then be used to purchase a June 295 call option, which traded around $12.45 per contract yesterday.
As the sold put is slightly higher than the bought call, the trader receives a credit into their account of $1.15 per contract, or $115 in total.
Risks And Rewards
This is not a case where the premium is the most the trade can lose. The 265 short put has a total loss potential nearly the same as owning the stock outright. In the unlikely event that Amgen stock went to zero, you would lose $26,500 to cover the short put with just a slight offset from the $115 premium collected.
But also like a stock position, the trade has unlimited profit potential.
This risk reversal option trade has a delta of 77, which means the combined position is roughly equivalent to owning 77 shares of Amgen stock.
At expiration, if AMGN stock is between 265 and 295 then both options expire worthless and the trader makes $115 in profit by keeping the premium collected.
As the stock rises above 295, the call option becomes more valuable with no limit to the profit potential.
Setting Exposure Right
According to the IBD Stock Checkup, Amgen stock is ranked No. 9 in its industry group and has a Composite Rating of 93, an EPS Rating of 87 and a Relative Strength Rating of 94. Its sharp rise in October was a factor fueling the outperformance of the Dow Jones Industrial Average.
For a trade like this I would risk no more than 2% of my account and have a stop loss if Amgen stock breaks through 255.
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
