MP Materials was yesterday's IBD Stock of the Day and is currently above a buy point of 47.40 from a cup-with-handle pattern. With MP stock above all key uptrending moving averages, it could have further to go. This option play participates on the upside with limited downside.
According to the IBD Stock Checkup, MP stock is ranked No. 1 in its group and has a Composite Rating of 99, an EPS Rating of 70 and a Relative Strength Rating of 95. The Mountain Pass site of MP Materials holds potential for shifting some of the dependence on China for rare earth mining. These materials are critical for many areas of renewable energy technology.
Call Options Provide Leverage
Investors who think MP stock will continue to rally but don't want to risk significant capital can use long call options. It gets you exposure to the upside move in MP stock without buying the stock outright. This can be a good way to protect precious capital in these volatile markets.
A call option is a contract between a buyer and seller. The contract gives the buyer the right to purchase a certain stock at a certain price (strike price) up until a certain date (expiration date).
One of the benefits of call options is that they provide leverage. But be warned, this can be both a good and a bad thing.
Assuming an investor wanted to buy 100 shares of MP stock, they would have to invest around $4,900 for 100 shares at the current price. As an alternative, the investor gains similar exposure using a fraction of the capital by buying a call option. One call option contract gives the investor exposure to 100 shares.
MP Stock Exposure At A Fraction Of The Price
If an investor buys one call option on MP stock with a 50 strike and June 17 expiration, the capital outlay is around $595, rather than spending $4,900 for the stock.
Of course, you have to take into consideration the option premium you paid when determining where you profit. The break-even price for the call option on MP stock is equal to the strike price plus the premium paid of around 5.95. The break-even price in this example is 55.95.
The most the trade can lose is the premium paid of $595. It MP stock finishes below 50 on June 17, the option expires worthless.
However, if MP stock shoots higher, the upside is unlimited.
Using options in this way gains exposure to a stock without risking as much capital as buying the stock outright.
Another Way To Limit Risk
Savvy traders can further reduce risk by selling an out-of-the-money call. That action turns the trade into a bull call spread.
For example, selling the 55 call with the same June 17 expiration reduces the trade cost by around $410. The premium you receive offsets your cost. But it also limits your upside. Your profits are capped if MP stock gets above 55 at expiration.
MP stock is set to announce earnings around the end of May, so this trade would have earnings risk if held to expiration.
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 Twitter at @OptiontradinIQ
