The Smart Way to Trade Ford: 100%-Plus Upside with Limited Risk
After the post-crisis recovery run from $2, Ford (NYSE: F) share prices peaked at $19 in 2011. A much-needed Bull rally breather has retraced half of that move to find solid price support around the $10 level.
Interestingly Ford has tracked in a trading range between $13 and $10 for nearly a year. The resent drop to the double-digit price base is an opportunity to use the power of options for a capital preserving, stock substitution strategy.
The January 2014 option has over one and a half years to develop into a profitably trade.
The actual shares are relatively inexpensive right now, but buying shares would tied up money that could be put to better use. An In-The-Money option gives you the right to be long the shares from a lower strike price and costs much less than the stock.
Bullish divergence has also appeared in the options implied volatility, with less fear in the recent price declines. This can mark a bottom as the emotional selling extremes may have been exhausted.
Shares of F have dropped 40%-plus since the peak with an extended sideways move building a base. A halfway bounce from those highs to recent lows conservatively targets $14. That would blast right through the upside resistance top at $13 with a target at $16.
The Options Way: Unlimited Upside Potential with Limited Risk.
A Ford long call option can provide the staying power in a potential larger trend extension. More importantly, the maximum risk is the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.
Choosing an option can sometimes be a daunting task with all of the choices and expirations. Simply put, traders want to buy a high probability option that has enough time to be right.
The option strike price is the level at which you have the right to buy without any obligation to do so. In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for a gain or loss.
There are two rules options traders need to follow to be successful.
Rule One: Choose an option with 70%-plus probability. The Delta is a measurement of how well the option reacts to movement in the underlying security. It is also important to buy options that payoff from only a modest price move.
There is no need to ONLY make money on the all but infrequent long shot price explosions. Good options profit from only modest directional moves.
Any trade has a fifty/fifty chance of success. Buying options ITM options increase that probability. That Delta also approximates the odds that the option will be In The Money at expiration.
Better options are more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot Out Of The Money lottery tickets that rarely ever pay off.
With F trading at $10, for example, an In The Money $8 strike option currently has $2.00 in real or intrinsic value. The remainder of any premium is the time 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 develop. Time is an investor’s greatest asset when you have completely limited the exposure risks.
Traders often buy too little time for the trade to develop. Nothing is more frustrating than being right but only after the option has expired premature to the market move.
Trade Setup: I recommend the January 2014 F $8 Call at $3.00 or less. A close in the stock below $9 on a weekly basis or the loss of half of the option premium would trigger an exit.
An option play also has staying power with the ability to ride through ups and downs that would force most stock traders out of the position. The option also behaves much like the underlying stock with a much less money tied up in the investment. The January 2014 option has nearly a year and seven months for development.
The maximum loss is limited to the $300 or less paid per option contract. The upside, on the other hand, is unlimited.
The Ford option trade breaks even at $11.00 at expiration ($8 strike plus $3 option premium). That is just a dollar above Ford’s current price. If shares hit the initial modest $14 price target above, the option investment would DOUBLE for 100%-plus return on investment.