Coinbase stock is up around 100% in six weeks. Is that a little too far, too fast? Maybe. The problem with shorting a stock that is going parabolic is that it can keep going higher for longer and faster than you can tolerate. That's why a risk-defined option strategy is a better way to go for COIN stock. Enter the bear call spread.
Bear Call Spread On COIN Stock
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call. Applied to COIN stock, the strategy can be profitable if the stock trades lower, sideways or even slightly higher. COIN stock just has to stay below the short call at expiry.
A 155-160 bear call spread expiring on Dec. 8 was showing a nice premium of around 90 cents at the close yesterday. That means traders selling the bear call spread on Coin stock collected $90 in premium. That's also the maximum possible gain — not much, but not bad for a trade with less than a week to expiration.
The maximum loss is $410. To calculate the maximum loss, take the distance between the strikes, multiply by 100 (500) and subtract the premium received (90).
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The spread will achieve the maximum profit if COIN stock closes below 155 on Dec. 8, in which case the entire spread expires worthless. It allows the trader to keep the entire $90 option premium.
The maximum loss will occur if shares close above 160 on December 8. That would see the premium seller lose $410 on the trade.
Limiting Risk On Highflying Stocks
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy. You always know the worst-case scenario in advance. That feature allows the trade to be used in a retirement account, whereas shorting a stock isn't allowed.
This is a very short-term, risky trade, but it could pay off nicely if COIN stock pauses here for a few days.
A stop loss could be set if Coinbase trades above 155, or if the spread value rises from 90 cents to $1.80.
As this is a bearish position, traders who think COIN stock could move higher from here should not enter this trade. The position starts with a delta of -6, meaning it is roughly equivalent to being short six shares of COIN stock.
According to the IBD Stock Checkup, Coinbase stock is ranked No. 6 in its group and has a Composite Rating of 96, an EPS Rating of 69 and a Relative Strength Rating of 99.
It's important to 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
