Liberation Day was supposed to invigorate the U.S. economy, at least according to the Trump administration. And logically, it would seem to make sense, as protectionist policies should in theory bolster domestic enterprises. Unfortunately, the market had other ideas. Over the past five sessions, the benchmark S&P 500 lost 9.5%, which many would consider a strong repudiation of the president’s mandate.
Irrespective of one’s political preferences, though, President Trump succeeded in a key area: he crafted an unprecedented platform for market speculation.
Granted, I don’t think he meant to do this. However, if you’re a fan of exploiting unusual options activity — especially when said activity is favorably inefficient — then this may very well be the greatest time in history. If you know where to look (and have basic spreadsheet skills), you potentially stand to make a killing through smart positioning and tactics.
Moving with the Money
Easily one of the greatest tools in the Barchart arsenal is the options screener. By setting defined parameters, you can easily find opportunities that match your specific risk-reward tolerances. In this particular case, I was looking for bull call spreads that expire this Friday that would give me the greatest bang for the buck.
I believe I found exactly that with Broadcom (AVGO); specifically, the 148/152.50 bull call spread. This transaction involves buying the $148 call (at an ask of $1,055) and simultaneously selling the $152.50 call (at a bid of $755), resulting in a net debit paid of $300. This figure also doubles as the most that can be lost in the trade.
Now, if AVGO stock breaches the short strike price at expiration, the speculator collects the maximum reward, which is the difference between the strike prices (multiplied by 100 shares) minus the net debit paid, or $150. This translates to a maximum payout of 50% or risk/reward ratio of 2-to-1.
Here’s the thing about this call spread. The price that the security needs to reach is already lower than the current market price. On Monday, AVGO stock finished the session at $155.62. So, the aforementioned short strike price is 2% lower than the market.
That’s right — AVGO stock can lose 2% between now and Friday and you would still be in line to collect a 50% payout.
AVGO Stock Call Spreads Demonstrate Risk Inversion
What we’re seeing right now in the market is what I would term risk inversion. In a typical bull call spread, the underlying security usually needs to rise to be profitable. That’s because you’re paying for the hope of seeing a specific outcome materialize, which is the key characteristic of a debit distribution.
On the other hand, call spread sellers are underwriting the risk that the aforementioned outcome will not materialize. For sellers, they’re not necessarily betting against a security; rather, if the stock merely moves sideways, they should be able to keep all the premium collected from underwriting said risk. Naturally, these bear call spreads are credit-based strategies.
Right now, the risk is so intense that market makers aren’t just offering garden-variety debit call spreads…no, they’re offering debit spreads that have margins of safety built into them. In other words, the debit buyer isn’t just buying a contract in the hope that it becomes profitable. Instead, the contract is already profitable on paper and deeply so.
Therefore, the debit buyer can win in three ways: the stock moves up, the stock moves sideways or the stock moves modestly down. That’s the kind of risk profile that is typically afforded to credit underwriters, not debit speculators.
Using Simple Math to Make Big Profits
If you aren’t already excited about AVGO stock call spreads, here’s the kicker: with the aforementioned 148/152.50 call spread for the April 11 expiration date, the house advantage is massive — and it’s in your favor!
As of this writing, Barchart notes that the probability of profit for this call spread is 60.3%. However, I would argue that the odds are higher. Downloading AVGO’s price data, I calculated that there have been 817 complete weeks in the books so far. Of this figure, 466 weeks were positive weeks, providing a weekly success ratio of 57.04%.
But we’re not interested in whether AVGO stock will rise on any given week. Remember, we have a 2% safety margin to the short strike price. This means that as long as AVGO performs better than a 2% weekly loss, we win.
And what are the odds that AVGO will deliver a return better than a 2% loss?
73.81% or 13.51% of free odds baked into the price of the 148/152.50 spread. You’re not going to find too many options trades with this kind of risk inversion.
