Shopify sold off 6.18% on Friday and is now back below the 21-day moving average. With the market in correction again, traders might consider a bearish trade on Shopify stock known as a bear put spread.
A bear put spread is a debit spread, meaning that we need to pay the premium to open the trade.
If we place the bear put spread out of the money, we have a trade with low cost and a high reward potential if the stock drops.
On Shopify stock, a bear put spread could be set up using the 320 strike as the long put and the 310 strike as the short put for the September expiration.
This trade would cost around $440 per contract with a maximum potential gain of $560. Placing the trade further out of the money would create an even more favorable risk-to-reward scenario.
Maximum Profit If Shopify Stock Falls 12% By Expiry
To achieve the maximum profit, this trade would need SHOP stock to drop 12% between now and expiration on Sept. 16.
The break-even point for the bear put spread is 315.60, which is calculated as 320 less the $4.40 option premium per contract.
If Shopify stock drops early in the trade it may be possible to make a profit at slightly higher prices.
At expiration, if SHOP stock is trading above 320, the entire spread would expire worthless, and the trade would lose 100% or $440.
For a trade like this, I wouldn't bother with a stop loss. Either the trade works or it doesn't. So I would trade an appropriate position size in case I suffered the full 100% loss. Alternatively, you could set a stop loss at 50% of the premium paid.
Trade Is Fully Bearish On Shopify
As this is a bearish position, traders who think Shopify stock could move higher from here should not enter this trade.
According to the IBD Stock Checkup, SHOP is ranked No. 43 in its group and has a Composite Rating of 29, an EPS Rating of 62 and a Relative Strength Rating of 5. Those are poor numbers.
Earnings are set for early August, so this trade would have earnings risk if held to expiry.
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
