United Rentals was Tuesday's Stock of the Day, with two potential buy points on its chart.
According to the IBD Stock Checkup, URI stock is ranked No. 1 in its group and has a Composite Rating of 99, an EPS Rating of 96 and a Relative Strength Rating of 90.
When it comes to options, we normally look at short-term trades — anywhere from one week to one month. Today, we will look at a longer-term bull put spread.
Longer-term option trades tend to move a little slower than shorter-term trades. That allows more time to adjust or close the trade, but also means a lower annualized return.
Risk Is Defined Ahead Of Time
As a reminder, a bull put spread is a defined-risk strategy, so you always know the worst-case scenario in advance.
This type of trade will profit if United Rentals stock trades sideways or higher and even sometimes if it trades slightly lower.
With United Rentals trading around 347, if we use the June 16 expiration, we can sell a 280 put and buy a 270 put to set up the bull put spread. That spread was trading around $2.25 Tuesday. Keep in mind that liquidity is lower in longer-term options, which means it can be harder to get a good fill price.
Selling this spread would generate roughly $225 in premium with a maximum risk of $775.
If the spread expires worthless, that would be a 29% return in six months, provided URI is above 280 at expiration.
Maximum Loss Below 270
The maximum loss would occur if United Rentals closes below 270 on June 16. That would mean the premium seller loses $775 on the trade.
The break-even point for the trade is 277.75, which is calculated as 280 less the $2.25 option premium per contract.
I would set an adjustment point or a stop loss if United Rentals drops below 305. Otherwise, another good rule of thumb is to limit the loss to the amount of premium received. In this case, that would be $225.
Sticking to this stop-loss level will help avoid large losses if the trade goes south.
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
