The S&P 500 has recovered nicely, but is not entirely out of the woods with some caution still warranted.
Merck stock has been struggling since the July 30 earnings announcement, which saw the stock plunge through the 200-day moving average.
Merck stock is down 11% in the last three months and could potentially be headed for new lows.
If Merck continues to move lower a bear put spread would be the best way to trade it.
A bear put spread is a debit spread, meaning we need to pay the premium to open the trade.
On Merck, a bear put spread could be set up using the 105 strike as the long put and the 100 strike as the short put. We'll use the Nov. 15 expiration.
Maximum Profit Of $420
This trade would cost around $80 per contract with a maximum potential gain of $420.
To achieve the maximum profit, this trade would need Merck stock to drop a further 13% between now and expiration on Nov. 15.
The break-even point for the bear put spread is 104.20. That's calculated as 105 less the $0.80 option premium per contract.
If Merck stock drops early in the trade, it may be possible to make a profit at slightly higher prices.
At expiration, if Merck stock is trading above 105, the entire spread would expire worthless, and the trade would lose 100%, or $80.
Exit Strategy For Merck Stock
For a trade like this, I wouldn't bother with a stop loss. Either the trade works or it doesn't. So I would trade an appropriate position size in case I suffered the full 100% loss. Alternatively, you could set a stop loss at 50% of the premium paid.
Because this is a bearish position, traders who think Merck stock could move higher from here should not enter this trade.
According to the IBD Stock Checkup, Merck stock is ranked number 10 in its group. It has a Composite Rating of 62, an EPS Rating of 82 and a Relative Strength Rating of 31.
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 X/Twitter at @OptiontradinIQ
