McDonald's is showing improving relative strength. And last week, the stock broke back above the 200-day moving average. Investors thinking McDonald's stock will continue to rally could do so in a reduced-risk way with options.
So, let's take a look at how we can use options to find a favorable risk-vs.-reward trade on the assumption that McDonald's stock might move toward 290 in the next few weeks. Specifically, we will look at a bullish diagonal spread that allows traders to get long MCD without risking too much capital.
McDonald's Stock Today: The Setup
A bullish diagonal spread trade involves buying a long-term call option and selling a shorter-term, out-of-the-money call option against it.
So in the case of McDonald's stock, buying the Dec. 20 expiration 270-strike call will cost around $1,835, based on recent trading. (Amid Monday's rally, the premium of that call jumped again.) And selling the Sept. 20, 285-strike call option will generate around $145 in premium.
That results in a net cost for the trade of $1,690 per spread, which is the most the trade can lose.
You can estimate the maximum profit at around $900 per set of contracts. But that can vary depending on changes in implied volatility. The maximum profit would occur if McDonald's stock closed right at 290 on Sept. 20. It represents a return of around 53%.
The idea with the trade? If McDonald's stock trades up to around 290, the diagonal spread will increase, resulting in a net profit.
Higher Reward, Lower Risk
A bullish diagonal spread is a good way to gain some upside exposure on a stock without risking too much if the move doesn't eventuate.
The combined position has a net delta of 47. This means the trade is roughly equivalent to owning 47 shares of McDonald's stock, although this will change as the trade progresses.
The suggested stop loss level is a close below 270.
Not No. 1
One risk factor with McDonald's stock are its poor ratings currently. According to IBD Stock Checkup, MCD ranked No. 10 in its group. It has a Composite Rating of 50, an EPS Rating of 69 and a Relative Strength Rating of 35 over a 12-month period.
The Chicago-based fast-food icon is due to report earnings in late October, so this trade should have no earnings risk if held to expiration.
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
