Merck is struggling to get back above its downward-slanting 50-day moving average. Therefore, traders who think Merck stock will either remain stagnant or not rise significantly might consider a bear call spread trade.
Let's look at how a bear call spread might be set up on MRK.
As a reminder, a bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.
The strategy can turn a profit if the stock trades lower, sideways, and even if it trades slightly higher, as long as it stays below the short call at expiry.
Merck Stock Today
On MRK stock, an April expiry bear call spread could be set up using the 110 strike as the short call and the 115 strike as the long call.
On Tuesday, that spread in Merck stock traded around $0.60. Since then, the spread has narrowed to around 47 cents.
If executed based on the price of Merck stock on Wednesday morning, the maximum profit on the trade would be $47 per contract with a maximum risk of $453.
The spread will achieve the maximum 10.4% profit if Merck stock closes below 110 on April 21, in which case the entire spread would expire worthless, allowing the trader to keep the $47 option premium.
Risk Vs. Reward
The maximum loss will occur if MRK closes above 115 on April 21. The premium seller would lose $453 on the trade.
While some option trades have the risk of unlimited losses, this bear call spread defines risk. You always know the worst-case scenario in advance.
Could you set a stop loss? Yes. Watch if Merck stock trades above 110, or if the spread value rises sharply — say from $0.47 to $0.94. Additionally, as this is a bearish position, traders that think MRK will continue moving higher from here should not enter this trade.
Please remember that options are risky, and investors can lose 100% of their investment.
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
