The bull market run in 2014 has not treated all equally. While
the broad market S&P 500 is up 6.5% for the year, the Dow
industrials have only eked out a 1.7% gain. If the bull continues
its charge into 2015, the blue chips are likely to play catch
One of the components that has held the Dow back is
Wal-Mart Stores (NYSE:
, which is down almost 5% year to date.
WMT has been largely bound by a range between $72 and $80 for
the past year and a half. The stock is currently trading above
solid support at $72, and I believe the risk/reward favors the
bulls at these levels. An upside breakout through $80 resistance
targets an $8 move to $88.
The $88 target is about 18% higher than recent prices, but
traders who use a capital-preserving, stock substitution strategy
could make more than 140% on a move to that level.
One major advantage of using a long call option rather than
buying a stock outright is putting up much less capital to
control 100 shares -- that's the power of leverage. But with all
of the potential strike and expiration combinations, choosing an
option can be a daunting task.
You want to buy a high-probability option that has enough time
to be right, so there are two rules traders should follow:
Rule One: Choose a call option with a delta of 70 or
An option's strike price is the level at which the options buyer
has the right to purchase the underlying stock or ETF without any
obligation to do so. (In reality, you rarely convert the option
into shares, but rather simply sell back the option you bought to
exit the trade for a gain or loss.)
It is important to buy options that pay off from a modest
price move in the underlying stock or ETF rather than those that
only make money on the infrequent price explosion. 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.
The options Greek delta approximates the odds that an option
will be in the money at expiration. It is a measurement of how
well an option follows the movement in the underlying security.
You can find an option's delta using an options calculator, such
as the one offered by the CBOE.
With WMT trading near $74.80 at the time of this writing, an
in-the-money $67.50 strike call option currently has about $7.30
in real or intrinsic value. The remainder of the premium is the
time value of the option. And this call option has a delta of
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 greatest asset 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
With these rules in mind, I recommend the WMT Mar 67.50 Calls
at $8.50 or less.
A close below $70 in WMT on a weekly basis or the loss of half
of the option's premium would trigger an exit. If you do not use
a stop, the maximum loss is still limited to the $850 or less
paid per option contract. The upside, on the other hand, is
unlimited. And the March options give the bull trend almost eight
months to develop.
This trade breaks even at $76 ($67.50 strike plus $8.50
options premium). That is less than $1.50 above WMT's recent
price. If shares hit the $88 target, then the call option would
have $20.50 of intrinsic value and deliver a gain of more than
Action to Take -->
-- Buy WMT Mar 67.50 Calls at $8.50 or less
-- Set stop-loss at $4.25
-- Set initial price target at $20.50 for a potential 141% gain
in eight months
By using a similar options strategy, my colleague Amber Hestla is
generating payments of $1,047, $2,435, $3,410 (and sometimes
more) from nearly any stock -- including ones you already own.
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This article was originally published at
Under $1,000 Bet on Wal-Mart Could Make Traders
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