Spotify is one of the strongest stocks in the market, rising more than 50% in the last six months, compared with a 9% loss for the S&P 500.
Spotify is due to report earnings April 29 before the market open, and the options market is pricing in an 11.7% move in either direction. The stock has risen following the last six earnings announcements. However, that doesn't guarantee it will rise again this time, but it's a good sign of strength.
Let's analyze how we can structure an option trade that fits the view that we think shares of music streaming service Spotify will not drop by more than the expected move. This is similar to a previous idea on Chipotle Mexican Grill.
Structuring a Bull Put Spread for Spotify Stock
Taking the at-the-money put and call for the May 2 expiration, and adding the premiums together comes out to a 70-point move. That's an expected range of 11.7% in either direction. Now that we know the expected range, let's find a bull put spread that has a breakeven price roughly 11.7% below the stock price.
Selling the May 2, 535-strike put and buying the 530 put would create a bull put spread. This spread is trading for around $1.70. That means a trader selling this spread would receive $170 in option premium and would have a maximum risk of $330.
That represents a 52% return on risk between now and the end of the next week if Spotify stock remains above 535.
If Spotify stock closes below 530 on the expiration date, the trade loses the full $330. The breakeven point for the bull put spread is 533.30. That is calculated as 535 less the 1.70 option premium per contract.
There is little room for adjustment with short-term trades such as this held over earnings.
Wide Bid-Ask Spread
Also, keep in mind that the bid-ask spread is quite wide, so don't force the trade. Only enter it if you can get it filled at a good price. A 52% return in a few days would be nice, but the possibility of losing 100% is also very real.
As such, this style of trade is only for traders with a high-risk tolerance and a bullish outlook for the stock.
According to Investor's Business Daily's IBD Stock Checkup, Spotify stock is ranked No. 1 in its group. It also has a Composite Rating of 99, an Earnings Per Share Rating of 81 and a Relative Strength Rating of 97.
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, and is conservative in his style. He believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ.
