Earlier this week, I explained how Friday’s ugly decline has a silver lining.
Today’s trade is an application of this strategy.
If the market shows any sign of rallying this stock could create a big opportunity to put on an option position for $0 cost that could yield $1,000 per contract!
This looks particularly attractive because this stock looks like it wants to go higher with or without the market’s cooperation.
Read below to get the details, so you don’t miss it.
The silver lining in Friday’s ugly decline is that the high of Friday marks a significant benchmark for traders to measure relative strength between stocks and the market.
In other words, a stock that trades over Friday’s high before the market does is indicating that it is stronger than the market, and these are the best stocks to be in when the market rallies.
When you combine this with a good chart pattern, you have a great trade set up.
As you can see in the chart of Chubb (CB) below, it fits this description perfectly.
On Wednesday, CB closed over Friday’s high and a swing high.
If its momentum continues, it is poised to move higher.
The buy trigger is a trade over $157.50, but don’t pay more than $158.
The stop is under $154.50.
You could simply do that trade by buying stock.
However, if you understand options, look at this…
The Oct. 160/170 call spread costs about $2.30.
If CB rallies over 170, which it could easily do, by October 19th, that $2.30 will be worth $10. That’s a 450% gain.
However, you can do better.
The Oct 145/155 put spread could be sold for about $2.30 or more.
This means you can collect $2.30 to pay for the $2.30 you’re spending on the call spread and effectively get the trade that could yield $10 per contract for no cost.
This also means that between now and October 19th, for $0 cost, you have the opportunity to bank $100 per contract for every dollar CB moves over $160 up to $170 where the profit will be maxed out at $1,000 per contract.
This means 5 contracts could yield $5k with $0 cash outlay.
However, this is not risk-free.
Even though CB has a tendency to trend consistently higher, the trade will lose $100 per contract for every dollar it goes below $155 down to 145 where the max loss will be $1,000 per contract.
Here’s how you calculate a practical plan for managing your risk.
Each contract (long the call spread and short the put spread) equates to being long about 50 shares.
If you exit the position at the stop level I suggested of $154.50 the expected loss would be around $150-$200 per contract
So the premise of the trade is to risk $200 with the potential to earn $1,000, and the options don’t cost you anything.
Being long options is where the big profits are made.
This is a way to keep that potential without taking the risk that a slow rally costing you the value of the call spread.
Rick Nartarian, Chief Investment Officer
Darwin Wealth Creation