Eli Lilly is taking a little pause after a nice move in the last month. If Eli Lilly stock continues to trade around 440, this calendar spread will profit.
Calendar Spread For Eli Lilly Stock
A calendar spread is an income trade that involves selling a short-term option and buying a longer-term option with the same strike price.
Usually this is done with monthly options, but it can also be done with weekly options.
Traders typically use call options unless the trade has a bearish bias in which case they would use puts.
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With Eli Lilly stock trading around 437, setting up a calendar spread at 440 gives the trade a roughly neutral outlook.
Here's how we could set this trade up for Eli Lilly stock:
- Sell 1 June 16 put with a 440 strike price @ 11.85 per share
- Buy 1 July 21 put at a 440 strike @ 17.45 per share
Analyzing The Trade
The price of the longer-term July option on Eli Lilly stock costs more than the shorter-term option from June. Taking the cost of the July option and subtracting the premium brought in from the June option gives you a net cost for the calendar spread of $560 per contract. This is also the most you can lose for the trade.
The idea with the trade is that if LLY stock remains around 440 for the next few weeks, the sold option will decay at a faster rate than the bought option. As the gap between the two option prices widens, the more profit increases.
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The max profit is roughly around $630 but that can change depending on changes to implied volatility. The break-even prices are also estimates depending on changes to implied volatility and are at 425.50 and 457.50.
Since the implied volatility impacts the calculations for calendar spreads, it's more of an advanced strategy and not recommended for beginners.
Profit And Loss Targets
For a trade like this I set a profit target of 20% and use a stop loss if Eli Lilly stock breaks through either 425 or 458.
I also limit my risk to no more than 2-3% of my capital.
According to the IBD Stock Checkup, LLY stock is ranked No. 2 in its group and has a Composite Rating of 89, an EPS Rating of 62 and a Relative Strength Rating of 95.
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
