You see a stock you want to get long in and want to trade options on it, but don’t know which ones to trade.
Do you go long calls, short puts, or something else entirely? There are multiple ways to go long a stock so it can be confusing which one to go with.
Here is the stock in question
Potash (NYSE: POT) took a dive on earnings last week and since then it has moved nowhere. $29 looks like it could be the bottom for Potash, at least in the short term. Using options you can get long Potash by going long calls, long call spreads, short puts, or short put spreads. These are not the only ways to get long a stock with options but these are best suited for our current situation.
Which strategy do you pick?
One of the first things you look at is volatility. With this recent drop in stock price it has pushed volatility to 47.08 percent. This is not the highest volatility for Potash in the last two years but it is nowhere near the lowest or average.
If you expect the stock to rise in price then volatility will begin to drop. Today the stock went up 0.6 percent and volatility dropped 7.8 percent. Dropping volatility will hurt a call or call spread’s price. So how do you put a rising stock price and dropping volatility in your favor? You use short puts and short put spreads.
The short put spread you want to look at is the September 30/28 put spread. This means you want to sell the September 30 strike and buy the September 28 strike.
You want to do this for a credit of 1.02 per 1 lot. Your breakeven price on this trade is going to be $29, which is under Potash support. The max you want to risk on this trade is 50 cents. If Potash is above $30 by September expiration then you will receive your full credit. It is unlikely that you will wait for September expiration. You will look to close out the trade when you can get 50 percent of our credit.
Adam Beaty is a weekly options expert and can often be found quoted or writing for Benzinga and Wall Street Journal. He’s the founder of The Options Prophet; an interactive newsletter, which builds consistency through trading credit spreads.
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