Insurance. We all want it and we need it. But where do we find it? The property and casualty insurance business has seen a surge under the backdrop of a rise in physical and economic concerns. Arch Capital Group is a leader in the group and today we'll look at a bull put option spread on ACGL stock to take advantage of its setup.
The Setup For ACGL Stock
ACGL stock is appearing in a number of highlighted spots within IBD and ranks No. 1 in the IBD Stock Checkup for its industry group.
When I use technical analysis to find ideal buying opportunities, I look for breakout stocks that come back to retrace a key upward trending support line. We have that here as ACGL stock is testing its 50-day moving average line after an earnings breakout in April. This retest of rising support is the value region in a growth stock that many patient investors watch for accumulation into the next move higher.
The bull put spread trade can be setup like this:
- Sell to open 1 ACGL Sept. 15 monthly 70 strike put at 2.90
- Buy to open 1 ACGL Sept. 15 monthly 65 strike put at 1.70
The total credit collected on this bull put spread is around 1.20 per spread this morning. The strategy allows time decay to work in our favor, and gives ACGL stock room to move around its 50-day moving average around 71.50.
Profits And Losses For The Trade
The maximum gain for the trade is the premium collected. If ACGL stock stays above 70 at expiration, both options expire worthless and you keep the full $120.
Options Trading Turns 50; What It Means For You
There's a difference of five between the strikes at 65 and 70. For the maximum risk, take that difference less the collected premium of 1.20 and that produces a result of 3.80. No matter how much the trade goes against you, you know your maximum risk ahead of time. The break-even price (before commissions) is 68.80. That's just the short strike minus the premium received. Below that price at expiration is where you start to incur losses.
That might not seem like much profit for the risk but it works out to a roughly 31.5% return on risk. Plus, this trade has a higher probability that we will be able to collect the full profit (around 85%). You can work this out by taking the cumulative delta of the trade which stands just below 15 to figure out this probability.
Strong leaders can be positioned using the bull put spread so that chart volatility allows us the exposure to the markets without expanding the risk. The market currently sits in a unique position with a low volatility reading on the VIX. But underneath the surface we're beginning to see a rise in the volatility of volatility. This can lead to whipsaw price action. Our goal is to become more powerful traders in the current environment.
Trade Management
Identify the key chart levels.
The weekly breakout level was 64 to 66 and since then ACGL moved to 78. Now it's retesting 72, just above the last congestion zone around 70. This is a noted pattern of retracement in this stock.
ACGL Stock Short Put Spread Scenarios
What could happen:
- ACGL stock moves higher and we collect the full profit into expiration.
- The stock moves lower but does not break our key support levels near 68 to 70 and holds steady.
- ACGL stock moves markedly lower under heavy volume for three days without lifting. This is a signal we must leave the position.
- The ideal motion, especially as we have news heavy cycles, is forming a base at new higher prices. That give traders a chance to reposition and add to their position over time.
Set an alert for the prices on the edges. If they trigger, give the trade a few days to wiggle through and then make your decisions based on your own risk profile.
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on Twitter and Stocktwits at @AnneMarieTrades
