Eli Lilly is a current Leaderboard stock that has held up relatively well so far this year.
Lilly stock is above the 50-day moving average and showing some relative strength. The stock rose above the 314.10 buy point of a flat base but has eased below it.
Let's look at how we can use options to find a favorable risk-to-reward trade on the assumption that Lilly stock might stay between 300 and 335 in the next two weeks. Lilly traded right around 300 at midday Thursday.
We will look at a bullish diagonal spread, which allows traders to get long LLY without risking too much capital.
A bullish diagonal spread is a trade that involves buying a long-term call option and selling a shorter-term, further out-of-the-money call option.
Trade About Equals Owning 17 LLY Shares
Structuring the trade at 310 give the trade around 17 delta, which is roughly equivalent to being long 17 shares of Lilly stock.
Selling the June 310-strike call option will generate around $930 in premium, and buying the August 290-strike call will cost around $3,270.
That results in a net cost for the trade of $2,340 per spread, which is the most the trade can lose.
The estimated maximum profit is around $650, but that can vary depending on changes in implied volatility. The maximum profit would occur if Lilly stock closes right at 310 on the June 17 expiration date.
The trade benefits from time decay because the short-term option will decay at a faster rate than the longer-term option.
Sweet Spot: Between 300-335
The ideal scenario for this trade is for the stock to stay between 300 and 335 for the next two weeks.
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 suggested stop loss level is a close below 290.
According to the IBD Stock Checkup, Lilly stock is ranked No. 2 in its group and has a Composite Rating of 96, an EPS Rating of 92 and a Relative Strength Rating of 96.
Other traders may prefer to try a pure income play, such as an iron condor on Pfizer.
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
