Mastercard has had a difficult few weeks. MA stock dropped from 418 to 381 and is currently testing the 200-day moving average. When a quality company has a big drop like this, I like to use a strategy called a diagonal put spread. This option strategy is an advanced strategy because it utilizes options over different expiration periods and different strike prices.
Setting Up A Diagonal Put Spread On MA Stock
The trade I'm looking at is selling a Nov. 17 put on MA stock with a strike price of 355. That put traded around 2.20 per share this morning.
We'll go further out in time with a buy for a Dec. 15 put on MA stock with a strike price of 340. That traded around 2.45.
The net cost on the trade is $25, the difference in the premiums, and that is the most the trade could lose should MA stock go higher.
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The maximum potential gain is around $500 which would occur if MA closes right at 355 on November 17. In that case, the short put expires worthless and you keep that premium. But your long put would increase in value getting closer to in-the-money plus a month's worth of time value.
What about the downside? The larger risk is if MA stock drops too much. The maximum potential loss is $1,525. This calculation takes the difference in the spread (15) multiplied by 100 and adds the cost of the trade (25).
Managing The Trade
The trade break-even prices are when MA stock is around 348 and 400. Aiming for a return of around 10% to 15% makes sense and I would set a similar stop loss.
The worst-case scenario is a sharp drop in Mastercard early in the trade. For this reason, if the stock drops below 355 in the next few days, I would also consider closing the trade early to minimize losses.
The initial trade setup has a delta of 3, meaning the position is roughly equivalent to being long 3 shares of MA stock. Note that this delta number can change significantly as the stock starts to move.
According to IBD Stock Checkup, MA stock ranks No. 3 in its group. Mastercard also has a Composite Rating of 89, an EPS Rating of 85 and a Relative Strength Rating of 84.
Note that Mastercard is due to report earnings on Oct. 26, so this trade has earnings risk.
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
