You Could Double Your Money If Shares Break This Barrier
With a strong macro equity uptrend under way and a very low-volatility environment, this is the perfect time to make long option purchases. One stock that is setting up an attractive call option play that could double your money is Walgreen Co. (NYSE: WAG).
Walgreen’s share price has not kept pace with the recent index rally to multi-year highs. A move above the $37 resistance, which is halfway between the highs at $52 and $22 lows, targets the 2011 peak at $45.
One major advantage of using long options rather than buying shares is putting up much less money 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.
Simply put, 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 an option with 70%-plus probability.
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 or ETF rather than those that only make money on the infrequent price explosion.
Any trade has a 50/50 chance of success. Buying in-the-money options increases that probability. Delta also approximates the odds that the option will be in 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 WAG trading around $36 at the time of this writing, an in-the-money $30 strike call currently has $6 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 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.
I recommend the WAG Jan 2014 30 Calls at $7 or less.
A close below $30 in the stock on a weekly basis or the loss of half of the option premium would trigger an exit. If you don’t use a stop, the maximum loss is still limited to the $700 or less paid per option contract. The upside, on the other hand, is unlimited. And the January 2014 option has a year and four months for the desired move to develop.
This trade breaks even at $37 ($30 strike plus $7 option premium). That is only around $1 above WAG’s current price. If shares rally back to the 2011 highs at $45, the option should double.
Recommended Trade Setup:
— Buy WAG Jan 2014 30 Calls at $7 or less
— Set stop-loss at $3.50
— Set price target at $14 for a potential gain of 100%