With the big run in indexes this month, it might seem odd to suggest going bearish. But that might be the better play for laggard stocks. Lockheed Martin has struggled in recent months and just failed right at its 200-day moving average line. Here's how to use a bear put spread on an expectation of further weakness in LMT stock.
LMT Stock Today: Why Bearish?
With the great run this month in many stocks, investors might be looking at increased exposure for an arguably extended market. Adding some bearish option trades can be a good way to hedge some of that exposure for a pullback or even a pause.
The lack of participation makes LMT stock a prime candidate for a bearish trade. It seems stuck right under its 200-day line and has overall poor ratings. According to IBD Stock Checkup, CRM stock ranks No. 30 in its group and has a Composite Rating of 76, an EPS Rating of 77 and a Relative Strength Rating at a paltry 39. Not the qualities of a leader.
If we set up a bear put spread for LMT stock, we'll pay a premium in order to open the trade but that also sets up our maximum loss.
With LMT stock trading around 450, we could set up a bear put spread using the March 15 expiration. Going with a long put at 435 and a short put at 430 cost about $165 per contract this morning. That's the worst-case scenario if you lose on the trade.
With a distance of 5 points between the strikes, the maximum potential gain is $335.
Managing The Trade
To achieve the maximum profit, this trade would need LMT stock to drop 3.3% between now and expiration on March 15.
The break-even point for the bear put spread is 438.35, which is calculated as 440 less the 1.65 option premium per contract.
If LMT stock drops early in the trade, it may be possible to make a profit at slightly higher prices.
At expiration, if LMT stock is trading above 440, the entire spread expires worthless and the trade loses 100%, or $165.
For a trade like this, I wouldn't bother with a stop loss. Either the trade works or it doesn't. Choosing an appropriate position size is critical in case I suffer the full 100% loss. Alternatively, you could set a stop loss at 50% of the premium paid.
As this is a bearish position, traders that think LMT stock could move higher from here should not enter this trade.
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
