The concern over sequestration by the federal government has
pressured defensestocks in the past month. But the United States is
the biggest military spender in the world, spending more each year
than the other top five countries combined. This tells me there is
a big picture buying opportunity in defense stocks like
Raytheon Co. (
Raytheonstock is trading about 10% below its highs from 2010 and
2012, near $60 a share. The stock's recent low around $52 is about
$8 below those highs, and adding that to the highs gives us a
target of $68 on a full trend recovery. The midpoint from the 2011
lows around $40 to the recent highs places strong technical support
at the $50 level.
The $68 target is about 27% higher than current prices, but
traders who use a capital preserving, stock substitution strategy
could make triple-digit profits on a move to that level.
One major advantage of using longcall options rather than buying
the stock outright is putting up much less to control 100shares --
that's the power ofleverage . But with all of the potential strike
andexpiration combinations, choosing anoption can be a daunting
Simplyput , you want to buy a high-probability option that has
enough time to be right, so there are two rules traders should
Rule One: Choose an option with 70%-plus
Delta is a measurement of how well an option follows the movement
in the underlying security. It is important to buy options that pay
off from a modest price move in the stock orexchange-traded fund (
) rather than those that only makemoney on the infrequent price
Any trade has a 50/50 chance of success. Buyingin-the-money
options increases that probability.Delta also approximates the odds
that the optionwill bein the money at expiration. In-the-money
options are more expensive, but they're worth it, as your chances
of success are mathematically superior to buying cheap,
out-of-the-money options that rarely pay off.
For example, with Raytheon trading at about $53.50 a share at
the time of this writing, an in-the-money $50 strike call currently
has $3.50 in real orintrinsic value . The remainder of any premium
is thetime value of the option.
Rule Two: Buy more time until expiration than you may need
-- at least three to six months -- for the trade to
Time is an investor's greatestasset when you have completely
limited the exposure risks. Traders often do not buy enough time
for the trade to achieve profitable results. Nothing is more
frustrating than being right about a move only after the option has
expired. With these rules in mind, I would recommend the Raytheon
Jan 2014 50 Calls at $6 or less.
A close below $50 in the stock on a weeklybasis or the loss of
half of the option premium would trigger an exit. If you do not use
a stop, the maximum loss is still limited to the $600 or less paid
per option contract. Theupside , on the other hand, is unlimited.
And the January 2014 options give thebull trend almost a year to
This trade breaks even at $56 ($50 strike plus $6 option
premium). That is about $2.50 above Raytheon 's current price. If
shares hit the upside breakout target of $68, then the call options
would have $18 of intrinsic value and deliver a gain of 200%.
Action to Take -->
Buy RTN Jan 2014 50 Calls at $6 or less. Set stop-loss at $3. Set
initialprice target at $18 for a potential 200% gain in one
This article originally appeared on ProfitableTrading.com:
This Defense Stock Could Land Traders 200%
Profits by 2014
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