Markets

This Iconic Stock Could Generate A 167% Return

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The S&P 500 has gained more than 7% so far this year, and just made new highs on Wednesday. A move to 2,000 and beyond seems all but assured.

The massive bull market run makes long candidates more difficult to pick, as many stocks seem overextended and ripe for a pullback. But it's hard to say when the correction will arrive, as the market has climbed relentlessly in the face of bad news.

At this juncture, if you're looking for outsized gains, it may be a smart move to go after lagging stocks, which arguably have less to lose and more upside as the market plods higher.

Sears Holdings (Nasdaq: SHLD ) looks like a good candidate for this strategy. The stock has had a challenging 2014 and is down 22% this year.

A channel from $32 to $44 has captured the majority of the price activity over the past 52 weeks. In recent months, the $38 midpoint of the range has held as support on a weekly basis, with a series of lower highs and higher lows signaling an impending breakout.

The upside target is calculated by adding the $12 height of the trading range to the breakout point at $44, which gives us an objective of $56.

The $56 target is about 45% higher than recent prices, but traders who use a capital-preserving stock substitution strategy could make 167% 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 1: Choose a call option with a delta of 70 or above.

An option's strike price is the level at which the options buyer has the right to purchase the underlying security 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 security 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 SHLD trading near $38.50 at the time of this writing, an in-the-money $30 strike call option currently has about $8.50 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 about 78.

Rule 2: Buy more time until expiration than you may need -- at least three to six months -- for the trade to develop.

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 has expired.

With these rules in mind, I recommend the SHLD Jan 30 calls at $9.75 or less. (Be careful when entering this trade as SHLD has special options listed that also expire on Jan. 17. The special options begin with SHLD1 as opposed to SHLD for the standard options.)

A close below $32 in SHLD 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 $975 or less paid per option contract. The upside, on the other hand, is unlimited, and the January options give the bull trend almost six months to develop.

This trade breaks even at $39.75 ($30 strike plus $9.75 options premium). That is about $1.25 above SHLD's recent price. If shares hit the $56 target, then the call option would have $26 of intrinsic value and deliver a gain of 167%.

Action to Take -->

-- Buy SHLD Jan 30 Calls at $9.75 or less

-- Set stop-loss at $2

-- Set initial price target at $10 for a potential 167% gain in six months

This article was originally published at ProfitableTrading.com:

On-Sale Retailer Could Net Traders 167% Profits by 2015

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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