Palo Alto Networks has been trading within a narrow range for the last month or so. That could mean it's a good time to look at a long strangle trade in Palo Alto stock and a potential breakout from the range.
A long strangle is constructed through buying an out-of-the-money call and an out-of-the-money put.
The trade aims to make a profit from a big move in either direction by the underlying stock.
Palo Alto Stock Today: The Trade Setup
Buying a long strangle is cheaper than a buying a long straddle, but will still suffer from time decay. That means the options will lose a little bit of value with each day that passes if Palo Alto stock doesn't make a big move.
With a long strangle, the further out in time the trade gets placed, the slower the time decay. However, the options get more expensive and require more capital.
For Palo Alto stock, traders could form a long strangle by buying a 330 strike call option and a 250 strike put option for the May 17 expiration. The monthly call option traded around $3.30 and the put at around $2.40, based on recent prices. When we add the two together, the cost totals around $5.70 per set of contracts, or $570 for a block of 100 shares.
A Fixed Maximum Risk
This is the total amount of risk in the trade and the maximum that could be lost.
Calculate the break-even prices by taking the strike price plus or minus the cost of the strangle.
That gives us break-even prices of 244.30 and 335.70 in Palo Alto stock. But traders can score profits with a smaller move if the move comes earlier in the trade.
For example, the estimated break-even prices at April 15 are around 261 and 305.
Changes to implied volatility will have a big impact on this trade and the interim break-even prices, so it's important to have a solid understanding of volatility before placing a trade like this.
Palo Alto Stock: Best And Worst-Case Scenarios
The ideal scenario is a large move in either direction within the first week or two of the trade.
The worst-case scenario with this long strangle? A stable stock price that would see the call and put options in Palo Alto stock slowly lose value each day. For a long strangle I usually set a stop loss at around 20% of capital at risk which would be around $110 and a profit target of around 40%.
I also wouldn't hold the trade any longer than April 15.
According to IBD Stock Checkup, Palo Alto stock ranked No. 8 in its group and has a Composite Rating of 90, an EPS Rating of 98 and a Relative Strength Rating of 70.
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 X/Twitter at @OptiontradinIQ
