Lennar joined the SwingTrader idea list yesterday after bouncing off the rising 21-day moving average. The timing might be right for a bull call spread to take advantage of a modest move in Lennar stock.
Setting Up The Bull Call Spread
Lennar stock is above its 21-, 50- and 200-day moving averages and the relative strength line is at new 52-week highs.
According to the IBD Stock Checkup, LEN stock is ranked No. 5 in its group and has a Composite Rating of 98, an EPS Rating of 96 and a Relative Strength Rating of 92. Its group, the residential and commercial builders, is No. 5 out of of IBD's 197 Industry Groups.
With implied volatility still quite low on Lennar stock, it's better to look at debit spreads rather than credit spreads.
A bull call spread is a bullish debit spread. You buy a call and then sell a further out-of-the-money call.
Selling the further out-of-the-money call reduces the cost of the trade but it also limits the upside.
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Going out to the June expiration, a 105-strike call option was trading around 8.45 yesterday, and the 110 call was around 6.05.
Buying the 105 call and selling the 110 call creates a bull call spread with a cost of 2.40. That means you have an outlay of $240 (difference in the option prices multiplied by 100).
Profits And Losses For Lennar Stock Option Trade
The most you can lose on the trade for a bull call spread it the cost. In this case, that's around $240. No matter how low the stock goes, your risk is capped at the cost.
But, your maximum potential profit is also capped. A close above 110 at expiration achieves the $260 maximum profit. To calculate the max profit, take the difference in strike prices, multiplied by 100 less the premium paid.
The breakeven price for the trade is equal to the long call strike plus the premium, which in this case would equal 107.40.
In terms of trade management, if the stock dropped below the February 10 low of 100.04, I would consider closing early for a loss.
Lennar is due to report earnings in mid-March, so this trade would have earnings risk if held until then.
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
