Dick's Sporting Goods stock jumped 3.7% yesterday after a solid bounce off its 50-day line last week. Investors who think DKS stock will continue to rally and don't want to risk significant capital can use long call options instead of buying the stock outright.
Getting Exposure With Less Capital
As a reminder, a call option is a contract between a buyer and seller. The contract gives the buyer the right to purchase a certain stock at a certain price (strike price) up until a certain date (expiration date). It's a good way to benefit in the upside gains while limiting the downside risk.
Another benefit of call options is that they provide leverage (though this can be both a good and a bad thing).
Assuming an investor wanted to buy 100 shares of DKS stock, they would have to invest around $14,500 at the current price.
Instead, the investor could gain a similar exposure to DKS stock using a fraction of the capital by buying a call option. One call option gives the investor exposure to 100 shares.
If an investor were to buy a 150 call option expiring on Sept. 15, they would only need to invest around $1,420 rather than $14,500.
The 150 call option has a delta of 51, which means it is roughly equivalent to owning 51 shares of DKS stock. However, that exposure will change over time as the stock moves.
DKS Stock Option Has Time
The break-even price for this call option is equal to the strike price plus the premium paid. At a current option price of 14.20, that puts the break-even price around 164.20. That's up there, but there is also a lot of time on this option to perform. If you get an early move higher, you can always sell the option early to book the profit.
Time decay gets brutal as the expiration approaches, especially in the last month. Since this call option on DKS stock has a lot of time, it won't be as big a factor for a while.
Also, since the expiration is far out, there isn't much trading in this option chain. But the spread between the bid and ask isn't too wide.
Managing The Trade
The most the trade can lose is the premium paid of $1,420, which would occur if DKS finished below 150 on Sept. 15.
However, if DKS stock shoots higher, the upside is unlimited.
Using options in this way can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
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Savvy traders can further reduce the risk by selling an out-of-the-money call, turning the trade into a bull call spread.
For example, selling the Sept. 15 160 call on DKS stock reduce the trade cost by around $1,000 to just $420. But it would also limit the upside above a stock price of 160 and make your maximum profit $580.
IBD Stock Checkup notes that DKS stock ranks No. 3 in its group and has a Composite Rating of 91, an EPS Rating of 72 and a Relative Strength Rating of 96.
Remember that options are risky and investors can lose 100% of their investment.
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
