PayPal Holdings took a beating after topping at the end of 2021. While it's had a strong move off its bottom, I think it has limited upside. Here's a bearish trade on PayPal stock that profits if PYPL drops, goes sideways or even trades a little higher. The strategy is called a bear call spread.
Bear Call Spread On PayPal Stock
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call. It benefits from the passage of time. Maximum profit comes in as long as PayPal stock stays below the short call at expiry.
According to the IBD Stock Checkup, PayPal stock is ranked No. 18 in its group and has a Composite Rating of 37, an EPS Rating of 75 and a Relative Strength Rating of 19. The low ratings are part of why its upside may be limited.
For PYPL stock, selling the spread with a 110 call and buying a 115 call, both with a September expiration, traded around 60 cents yesterday. I'm looking at selling the spread if it rises to 80 cents.
If executed at that price, the maximum profit on the trade is $80 per contract with a maximum risk of $420. That's nearly a 20% return on risk in just over a month.
Profit And Loss Levels
The spread achieves maximum profit if PayPal stock closes below 110 on Sept. 16. In that case, the entire spread expires worthless and the option trader keeps the $80 premium. Remember, for credit spreads, you receive the premium upfront.
The maximum loss occurs if PYPL stock closes above 115 on Sept. 16. By taking the difference between the strikes, multiplying that by 100 shares per contract and then subtracting the premium received, the maximum loss is $420 on the trade.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy, and you always know the worst-case scenario in advance.
A stop loss could be set if PYPL trades above 105, or if the spread value doubles from 80 cents to $1.60.
This is a bearish position. Traders that think PayPal stock is looking at more gains from here, shouldn't enter this trade. With a delta of -7, this trade is roughly equivalent to being short 7 shares of PYPL stock.
Revisiting Prior Trade Ideas
Here's a look at a couple prior trade ideas from this column.
A broken-wing butterfly on McDonald's looks like it can be closed early with a 10% profit. We also discussed a more advanced strategy last week with a diagonal put spread on Mosaic. That also has around a 10% profit and can be closed early.
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
