Valero Energy had a nice bounce off the 21-day line last week and joined SwingTrader on Wednesday. VLO stock worked off overbought conditions and is moving to new highs from its short pullback. Here's an option strategy that participates in an upside move with little capital at risk.
Limited Capital Outlay With Long Call Option
Investors who think VLO stock will continue to rally and don't want to risk significant capital can use long call options rather than buy the stock outright. This can be a good way to protect precious capital in these volatile markets.
A call option is a contract between a buyer and seller. The contract gives the 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 wants to buy 100 shares of VLO stock, they would have to invest around $13,200 at the current price.
Instead, an investor could gain a similar exposure using a fraction of the capital by buying a call option.
One call option gives the investor exposure to 100 shares.
If an investor buys one VLO 130 call option expiring on Dec. 16, they would only need to invest around $1,700 rather than $13,200.
Profit And Loss For A Long Call On VLO Stock
The break-even price for this call option on VLO stock is equal to the strike price plus the premium paid. For this trade, that makes a break-even price of 147.
The most the trade can lose is the premium paid of $1,700. That occurs if VLO stock finishes below 130 on Dec. 16.
However, if VLO stock shoots higher, the upside is unlimited.
Using options can be a great way to gain exposure to a stock without risking as much capital as buying the stock outright.
VLO stock is set to announce earnings around the end of July, so this trade has earnings risk if held to expiration.
According to the IBD Stock Checkup, VLO stock is ranked No. 1 in its group and has a best possible Composite Rating of 99, an EPS Rating of 76 and a Relative Strength Rating of 98. Its group, the Oil & Gas-Refiners, is ranked No. 8 out of IBD's 197 Industry Groups.
Another Option To Reduce The Risk
If the $1,700 premium is still more money than you want to spend, there is another option. You can turn the VLO stock trade into a bull call spread. By selling a Dec. 16 call with a 150 strike, you reduce the cost almost in half to $940.
What's the catch? You also limit your upside potential. No matter how high VLO stock goes, your profits are capped as the stock moves above 150.
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
