ServiceNow has maintained strong relative strength in recent months and is a leader in the Computer Software-Enterprise Group. With implied volatility near 12-month lows, a debit spread is more favorable over a credit spread so we'll look at a bull call spread on NOW stock.
NOW stock is currently trading above its 21-, 50- and 200-day moving averages and saw a nice bounce today from its 50-day line.
According to IBD Stock Checkup, NOW stock ranks No. 1 in its group and has a Composite Rating of 99, an EPS Rating of 99 and a Relative Strength Rating of 91. It's hard to find better than that.
NOW Stock Today: A Bullish Setup
With the support at the 50-day line and indexes looking to break through resistance, we'll take a bullish position on NOW stock. As a reminder, the bull call spread buys a call and then sells a further out-of-the-money call.
Selling the further out-of-the-money call reduces the cost, and therefore the risk, of the trade but also limits the upside.
Since this is a debit spread, we want to give ourselves time until expiration so we don't see a big degradation of time value. With NOW stock trading around 578 this morning, we could use the Jan. 19 expiration and buy the 600 call at 43.75 and simultaneously sell the 610 call at 39.20.
Managing The Trade
The trade costs 4.55 per spread, or $455. That is also the maximum loss for the trade if both options expire worthless with NOW stock below 600 at expiration. It makes the trade a defined-risk trade where you always know your worst case scenario in advance.
Maximum profit works out to 5.45, or $545 per spread. You simply take the difference in the strikes (10) minus the premium paid (4.55) to arrive at the max profit. That occurs with NOW stock trading above 610 at the Jan. 19 expiration.
It's important to note that while a long call gives you unlimited profit potential, the bull call spread does limit your upside. If NOW stock rockets way above 610, this trade won't participate. But the short call reduces the cost considerably, from $4,375 down to $455.
The break-even price for the trade is equal to the long call strike plus the premium, which in this case would equal 604.55.
In terms of trade management, if the stock dropped below 545, I would consider closing early for a loss.
The next earnings report for NOW stock is in October so this trade would have earnings risk if held until then.
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.
