This Beaten-Down Tech Stock Could Double Your Money
The recent decade-long-plus highs in technology stocks have left out some old standbys that need to tweak and reinvent their business plan. Hewlett-Packard (NYSE: HPQ) has dropped from highs near $50 in 2011 to trade at the lowest levels since 2004.
The three-month trading channel shown on the chart below between $17 and $20 looks attractive for a price breakout from the base action. A rally above the resistance top projects a $3 move, the width of the channel, to $23. Only a weekly close below $17 would negate the technical basing pattern.
The initial upside objective of $23 is 30% above the current stock price, but there is a way you could potentially double your money with a stock substitution strategy.
One major advantage of using long options rather than buying shares is putting up much less 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 HPQ trading around $17.75 at the time of this writing, an in-the-money $13 strike call currently has $4.75 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 HPQ Jan 2014 13 Calls at $5.75 or less.
This option strike gives you the right to buy more than $3 below the lowest point for the year with absolutely limited risk.
A close below $17 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 $575 or less paid per option contract. The upside, on the other hand, is unlimited. And the April 2014 option has a year and four months for the desired move to develop.
This trade breaks even at $18.75 ($13 strike plus $5.75 option premium). That is just $1 above HPQ’s current price. If shares hit my conservative initial price target of $23, the option should double.
Recommended Trade Setup:
— Buy HPQ Jan 2014 13 Calls at $5.75 or less
— Set stop-loss at $2.87
— Set price target at $11.50 for a potential 100% gain by January 2014 expiration