26 Oct Using Options to Increase your Profits
We love options here at Capital 19. You can use them in so many different and varied ways. They can take a bit to understand but there so is much free information out there on the web you can get your head around the basics fairly easily.
Today we want to use an example of one way you can use options to increase your profits and we are going to at an opportunity in Becton, Dickinson and Company (BDX)
BDX has been making and selling medical equipment since 1987. But it came up on our radar because it has a curious track record at this time of year.
Between October 26, and January 19, BDX stock has moved up, every year, for the last 18 years. Seeing as today is October 26 we got excited about the possibility for profits.
The average move-up between these dates for the last 18 years has been 9.09%. 9% in just 3 months is nothing to be sneezed at.
Additionally, we like the way this stock has been moving in a nice wide channel for almost 3 years.
The stock has been moving back and forth between about 220 and 270 for a long time and right now is in the lower half of that channel. It has just bounced off support at 220 and we are expecting a move back towards 270
This is a setup where both the seasonality and technicals are favouring a move higher. Based on past years the average move higher is 9%. If it can get up to 270 that would represent a 12% gain from here.
But look at what happens if we use options for this trade rather than buying the stock. The seasonal move ends January 19 so we will use the January 15 2021 expiry Call Options for this trade.
The stock last closed at 240.28
You can buy the 200 strike call for $42.90 and sell the 240 strike call for $13.50. This gives you a net outlay of $29.40 or $2490 per option contract.
Let’s take a look at the payoff at expiry for a range of potential stock prices
What this table is telling us is, if the stock finishes at $240 or above on January 15th, 2021, our option trade (called a Bull Call Spread) will result in a 36% profit. Almost 4 times better than the expected stock return.
If the stock closes 5% lower, then our spread will lose 3.8%, still better than the stock loss of 5%
As you can see, using a simple option trade like this improves our percentage returns as compared to buying the stock itself.
But there is always a risk for this. In this case, you can see the returns should the stock drop 10% or more. Our loss becomes larger than would happen in just buying the stock. The best way to manage this risk is with position sizing.
With the technical and seasonals lining up, we like the potential offered by BDX and as you can see, we can make it an even better potential return if we use options to increase our profits.