InMode is nearing a breakout and was yesterday's IBD Stock of the Day. With medical stocks getting more attention lately, this bullish option on INMD stock can get you exposure with limited risk.
According to the IBD Stock Checkup, INMD stock is ranked No. 1 in its group and has a Composite Rating of 99, an EPS Rating of 98 and a Relative Strength Rating of 92.
The medical systems and equipment group is a strong No. 30 out of the 197 industry groups tracked by IBD.
With tight action in a handle, INMD stock could be coiling up for a move. Using a long call option, traders can gain upside exposure with unlimited profit potential with less capital at risk than buying the stock outright.
How A Call Option Works
A call option is a contract between a buyer and seller. The contract gives the option buyer the right to purchase a certain stock at a certain price (strike price) up until a certain date (expiration date).
One of the benefits of call options is that they provide leverage (this can be both a good and a bad thing).
Assuming an investor wanted to buy 100 shares of INMD stock, they would have to invest around $3,700 at the current price.
Instead, the investor could gain similar exposure using a fraction of the capital by buying a call option.
One call option contract gives exposure to 100 shares.
Setting Up The INMD Stock Option Trade
If an investor were to buy a call option on INMD stock with a 35 strike expiring on Jan. 19, 2024, they only need about $770 in capital rather than $3,700.
The 35 call option has a delta of 69, which means it's roughly equivalent to owning 69 shares of INMD. However, that exposure will change over time as the stock moves.
The break-even price for this call option is equal to the strike price plus the premium paid. So it makes money if INMD stock finishes above 42.70 at expiration.
One of the great things about the long call option is that less capital is at risk and you always know your maximum loss in advance. You can't lose more than the $770 premium paid for the call option. If INMD stock finishes below 35 on Jan. 19, the option will expire worthless and you will lose the full amount.
However, if INMD stock shoots higher, the upside is unlimited.
Using options in this way can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
Managing The Trade
Savvy traders can further reduce the risk by selling an out-of-the-money call, turning the trade into a bull call spread.
For example, using the same Jan. 19 expiration, selling a 50 call reduce the trade cost by around $225 so you have even less capital at risk. But that comes with a cost. It also limits the upside potential once INMD stock gets above 50. While the long call option has unlimited profit potential, switching to this bull call spread caps your profit at just under $1,000 per contract.
Rather than reducing risk with a bull call spread, you could also use a stop loss on the call option. If INMD stock drops 8% from the entry point or if the value of the option trade drops by 40%, you can cut the loss before losing the full amount. With a long time until expiration, there's a lot of room to adjust the trade if needed.
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
