Chevron is currently one of the most oversold stocks in the Dow Jones Industrials Index.
Investors who think the energy sector is due to play catch up with the rest of the market could do so in a reduced-risk way, with the use of options.
Let's take a look at how we can use options to find a favorable risk-to-reward trade on the assumption that Chevron stock might move up toward 155 in four weeks.
We will look at a bullish diagonal spread, which allows traders to get long CVX without risking too much capital.
A bullish diagonal spread is a trade that involves buying a call option and selling a shorter-term, out-of-the-money call option against it.
Buying the March 15, 145-strike call cost around $755 late Monday and selling the Dec. 15, 155-strike call option will generate around $35 in premium.
Max Profit Could Reach $600
That results in a net cost for the trade of $720 per spread, which is the most the trade can lose.
The maximum profit is estimated at around $600, but that can vary depending on changes in implied volatility. The maximum profit would occur if Chevron stock closed right at 155 on Dec. 15.
The idea with the trade is that if CVX stock trades up to around 155, the diagonal spread will increase, resulting in a net profit.
A bullish diagonal spread is a good way to gain some upside exposure on a stock without risking too much if the move doesn't eventuate.
Trade Equal To Owning 45 Shares
The combined position has a net delta of 45, which means the trade is roughly equivalent to owning 45 shares of CVX stock. But this will change as the trade progresses.
The suggested stop loss level is a close below 137.
According to the IBD Stock Checkup, CVX stock is ranked No. 20 in its industry group and has a Composite Rating of 31, an EPS Rating of 12 and a Relative Strength Rating of 27.
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
