Chipotle Mexican Grill stock is showing elevated implied volatility with an IV percentile reading of 84%.
That means the current level of implied volatility is higher than 84% of other occurrences in the last 12 months.
When volatility is high, it can be a great time to look at option selling strategies like credit spreads.
Today, we're looking at an option credit spread called a bull put spread. As a reminder, a bull put spread is a defined-risk strategy, so you always know the worst-case scenario in advance.
Trade Works In Sideways Or Higher Action
This type of trade will profit if Chipotle stock trades sideways or higher, and even sometimes if it trades slightly lower.
With Chipotle trading around 1,845, if we use the November expiration we can sell a 1,700 put and buy a 1,690 put for around $1.85.
Selling this spread would generate roughly $185 in premium with a maximum risk of $815.
If the spread expires worthless, that would be a 22.7% return in seven weeks provided CMG stock is above 1,700 at expiration.
The maximum loss would occur if Chipotle stock closes below 1,690 on Nov. 17, which would see the premium seller lose $815 on the trade.
The break-even point for the trade is 1,698.15. which is calculated as 1,700 less the $1.85 option premium per contract.
When To Get Out Of The Trade
I would set a stop loss if CMG drops below 1,750. Otherwise, another good rule of thumb is to limit the loss to the amount of premium received. In this case, that would be $185.
Sticking to this stop loss level will help avoid large losses if the trade goes south.
According to the IBD Stock Checkup, Chipotle stock is ranked No. 1 in its industry group and has a Composite Rating of 94, an EPS Rating of 99 and a Relative Strength Rating of 80.
Keep in mind that Chipotle is set to report earnings around late October. So this trade would have earnings risk if held through that event.
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/X at @OptiontradinIQ
