United Parcel Service dropped below its 50-day moving average Wednesday and closed near the low of the day. If UPS stock continues to struggle, traders might consider a bearish trade known as a bear put spread.
A bear put spread is a debit spread, meaning that we need to pay the premium to open the trade.
On UPS stock, a bear put spread could be set up using the 165 strike as the long put and the 160 strike as the short put for the Feb. 17 expiration.
This trade would cost around $145 per contract with a maximum potential gain of $355.
Maximum Profit If UPS Stock Falls About 8%
To achieve the maximum profit, this trade would need UPS stock to drop 7.84% between now and expiration on Feb. 17.
The break-even point for the bear put spread is 163.55, which is calculated as 165 less the $1.45 option premium per contract.
If UPS stock drops early in the trade, it may be possible to make a profit at slightly higher share prices.
At expiration, if UPS stock is trading above 165, the entire spread would expire worthless, and the trade would lose 100%, or $145.
For a trade like this, I wouldn't bother with a stop loss. Either the trade works, or it doesn't. So I would trade an appropriate position size in case I suffered the full 100% loss. Alternatively, you could set a stop loss at 50% of the premium paid.
Trade Involves Earnings Risk
Because this is a bearish position, traders who think UPS stock could move higher from here should not enter this trade.
According to the IBD Stock Checkup, UPS stock is ranked No. 4 in its industry group and has a Composite Rating of 67, an EPS Rating of 88 and a Relative Strength Rating of 47.
UPS earnings are set for Jan. 31, so this trade would have exposure to earnings if held to expiration.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
