Palo Alto Networks was yesterday's IBD Stock of the Day as the cybersecurity stock forged a new buy point. Here's a bull call spread setup for PANW stock that offers participation in an upside move with limited risk.
Technical Picture Of PANW Stock
PANW stock is above its 21-, 50- and 200-day moving averages with strong relative strength in the last few months. The 50-day moving average just crossed over the 200-day moving average, a move known as a golden cross.
According to the IBD Stock Checkup, PANW stock is ranked No. 1 in its industry group and has a Composite Rating of 99, an EPS Rating of 97 and a Relative Strength Rating of 90. The industry group isn't ranked well, No. 106 out of IBD's 197 Industry Groups. But that's up significantly in the ranks from being at 187 in February.
Implied volatility is at a 12-month low and when that's the case it's better to look at debit spreads rather than credit spreads.
Setting Up A Bull Call Spread
A bull call spread is a bullish debit spread that starts with buying a call and then selling a further out-of-the-money call.
Selling the further out-of-the-money call reduces the cost of the trade but it also limits the upside.
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Going out to the June expiration, a 190-strike call option traded around 14.80 an hour into Tuesday's trading session. The 200 call traded around 9.90.
Buying the 190 call and selling the 200 call creates a bull call spread. The trade cost would be $490 (difference in the option prices multiplied by 100), and the maximum potential profit would be $510 (difference in strike prices, multiplied by 100 less the premium paid).
A bull call spread is a risk defined strategy, so if PANW stock closes below 190 on June 16, the most the trade can lose is the roughly $490 premium paid.
Potential gains are also capped above 200, so no matter how high PANW stock might go, the most the trade could profit is $510.
Managing The Trade
The break-even price for the trade is equal to the long call strike plus the premium, which in this case would equal 194.90.
In terms of trade management, if the stock dropped below the March 15 low of 181.63, I would consider closing early for a loss.
Palo Alto Networks is due to report earnings in mid-May, so this trade has 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
