Buy Call Options Or Sell A Put Spread?

Markets continued their historic run of extreme volatility this past week due to the spread of the coronavirus.

We are in the midst of a global economic slowdown that looks to be in place for the next few months at a minimum. While talk of a recession is no fun to go through, it does present opportunity for active options traders as long as you know where to look.

To take advantage of the current extreme market sentiment we are going to look at placing a bullish trade on Dollar Tree (Symbol: DLTR).

Why Dollar Tree For Options Trade

With so many people now working from home or even having their hours cut back there will be more shoppers looking to save money on everyday goods. This is why stocks like DLTR could get through an economic slow down better than others.

Looking at a the chart of DLTR we are seeing an oversold stock that has started to show signs of bouncing to the upside over the last 2 trading days. This has us neutral to bullish over the next 2-3 weeks.

We will take a look at 2 different ways of taking this bullish trade. We will compare buying outright call options to selling a put spread.

Does one of these trades have an advantage over the other given the current market conditions?

Trade #1: Buying Long Calls

For this trade we are:

• Using April monthly options that have 26 days left to expiration.
• We are looking to buy the April 70 calls for $9.00 or lower
• At the close on Friday these options were trading for $8.80.
• We would target a 100% return on this position while limiting the risk to 50% of what we pay for the position
• Our max loss would be 50% of what we pay on the position or around $440 per contract

Buying the long calls will give us a higher profit potential but a lower probability of success on the trade. The only way we make money on the trade is if the stock moves higher and does so quickly. The higher risk/higher reward nature makes this trade a perfect candidate for traders looking for an aggressive trade.

The trouble with this trade is if it takes too long or the move higher isn’t big enough the long call position would be hurt. It would also be hurt if volatility drops back down over the next few weeks. In other words there is a big profit potential but there are many factors that need to go right for the position to make money.

Trade #2: Selling A Put Spread

For this trade we are:

• Using April monthly options that have 26 days left to expiration.
• We are looking to sell the April monthly 70/65 put spread for $1.50 or higher
• This has us selling the 70 puts and buying the 65 puts at the same time for $1.50 or higher. At the close on Friday this spread was trading for $2.22
• We would be looking to close the spread when we can buy it back and keep between 50-75% of what we collected to put the trade on for
• Our max loss on the trade would be $278 per spread

Selling a Put Spread on the other hand still leaves us with a bullish position but does so in a more conservative way. We have a lower profit potential on the trade but it also takes less capital to put the position on. This leaves us with a lower risk/lower reward trade that is perfect for those trades that want to be active right now but do so with a safer trade.

The Short Put Spread gives us 5 ways of making money on the trade. We make money if the stock moves up, down, or sideways as long as the stock price stays above $67.78. We also make money from time decay adding up (every day that passes helps us), and if volatility decreases.

Having 5 ways of making money on the Put Spread makes it a more attractive trade given the market conditions. It’s a more forgiving trade that allows to make money in a range of different markets.

I much prefer the Short Put Spread to the Long Calls in this case and that is why we will be looking at the Spread for our Options Trade Of The Week.

For a complete break down of why we prefer the Short Put Spread for our Options Trade Of The Week make sure you review the video below.

You will learn the details of how we are placing trade including how we plan on managing it from start to finish.

If you are interested in learning how to find these trades, feel free to contact me directly with any questions you might have. Mike@netpicks.com.