Adobe, the IBD Stock Of The Day on Thursday, presents a strong candidate for options trading. One reason? Adobe stock shows a breakout from a recent buy point of 451.15 from a deep cup pattern, according to MarketSmith pattern recognition analysis.
Also, in the current formation, a potential retrace into a higher low makes for a new entry in Adobe stock — just above the 21-day exponential moving average.
The slope of motion, or the steepness of trend, continues to slow. This allows me to use the leverage of short options to minimize my cost to engage in potential upward trajectory.
Friday's jobs numbers release shows the first missed expectations in 14 months. As of this writing, stock market participants hold a slightly bearish view. Yet, there still lies a pervasive bid beneath the market. That is, traders continue to buy the dips and keep us in an uptrend.
My suspicion is that there are vast numbers of short sellers confident that a fade will ensue. This positioning means that they must buy to leave the market as it rises.
Using option configurations in emerging new leaders such as Adobe stock allows participation of a new uptrend with controlled downside. Such action remains an anchor for choosing option structure as the slope of motion slows while still trending.
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As we look inside the option toolbox, the calendar spread strategy allows for a potential pullback in Adobe stock. The possibility for a resumption of trend also exists.
Adobe Stock Today: Setting Up A Calendar Spread
To set up the trade, take these two steps:
- Sell to open 1 ADBE Aug. 18-expiration call with a 500 strike price
- Buy to open 1 ADBE Sept. 15 500 call
This calendar formation allows us to take advantage of potential downside pressure that might appear over the summer.
Total debit spent is $7.83 per spread. This trade has a total risk of $7.83 per share plus commissions, irrespective of price movement. Therefore, calculate the break-even price (before commissions) as 507.83, or the 500 strike price plus the debit amount.
The maximum return is potentially infinite if the trader takes delivery of the stock at the strike and the stock continues to rise over time.
Defending The Trade In Adobe Stock
Stock hunting using fundamental and price strength within the IBD methodology is where I firmly plant myself under the backdrop of the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
As with many of the tech picks into the second half of the year, expectation of slowing motion drives the trade analysis. Any bursts of price could push us to the next leg up. However, if the price action fades, our debit exposure is limited.
This spread in Adobe stock holds a short call in the front month and a long call in the forward month. The risk of $7.83 remains fixed, as the strength of the position lies in taking advantage of potential near term weakness by using the proceeds of the call to fund future expansion in the trade.
Managing The Trade: Key Chart Levels
The weekly near-term resistance zone sits near 520. The spread formation will begin to erode into negative returns if prices move above 500. Price action support sits near 450.
What could happen? Consider these scenarios:
- Adobe stock moves higher in the front month of August. I choose to use the Sept. 15 call to contain my risk.
- Stock moves lower and I lose 50% of the price of the premium of $7.83. So, I exit the trade using simple stop-loss rules for exit.
- Adobe stock stays within the region below 500 until after expiration in August. At this point, I own the Sept call at an excellent discount.
- If prices take a turn for the worse, I can now sell another call in Adobe stock against the Sept. 15 500 call. Then I collect more revenue during the fade, if that should occur.
And as with all trades, consider what you like about holding the position in the first place. Plus, always 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
