Mosaic dropped from 79.28 to 42.50 before the stock rallied back to as high as 54.84 this week. The stock is reclaiming both the 50-day moving average and the longer-term 200-day line, a pair of significant technical levels.
So, 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.
Let's look at an example with Tampa-based Mosaic and its stock using both monthly and weekly options.
Mosaic Stock: Setting Up A Diagonal Put Spread
The trade I'm looking at is selling an Aug. 19-expiring put in the agricultural chemicals producer with a strike price of 50 and buying a Sept. 2-expiration weekly put with a strike price of 48. As of Tuesday's close, the Aug. 19 put sold for around 1.40. And a trader could have bought the Sept. 2 put for 1.46 — costing $146 to get the right to sell 100 shares at the strike price of 48.
The net cost on the trade totals $6. That highlights the most the trade could lose on the upside.
This trade in Mosaic stock harbors a potential maximum loss of $206. This is calculated by taking the difference in the spread (2) multiplied by 100 and adding in the cost of the trade (6).
The maximum potential gain centers on $125, which will occur if MOS closes right at 50 on Aug. 19.
The Profit Zone
The trade has a nice profit zone from 47.80 to 57. Aiming for a return of around 10% to 15% makes sense. Plus, I would set a similar stop loss.
The worst-case scenario: You experience a sharp drop in MOS stock early in the trade. For this reason, if the stock drops below 48 in the next few days, I would also consider closing the trade early to minimize losses.
The initial trade setup has a delta of 5, meaning the position is roughly equivalent to owning 5 share of MOS stock. Note that this delta number can change significantly as the stock starts to move.
According to IBD Stock Checkup, Mosaic's stock ranks fourth in its agricultural chemicals group overall. It sports a Composite Rating of 95, an EPS Rating of 81 and a Relative Strength Rating of 94.
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
