It seems the market has taken a breather from its bullish start to 2012 over the last couple of weeks. Against this backdrop, some stocks have drifted down into areas of potential support. For certain securities, we could start to see rebounds off these areas, spurring a continued move higher.
United Technologies (NYSE:UTX) looks like a prime candidate for just that kind of behavior. For this trade idea, however, traders should be looking for a bullish reversal sign before buying the option.
The Trade Idea: Long Call
The trade: Buy the UTX May 82.5-strike calls for a debit of $2.15 or less. With the stock at $81.80, these calls are out-of-the-money by 70 cents.
The strategy: This long call trade idea will profit if the stock rises, pushing the call premium higher than the investor paid to enter the position. Delta for this call is currently 47, meaning the call premium will increase by 47 cents for every $1 advance in the shares. Delta is a fluid variable that will change based on stock price, time until expiration, and other factors.
Maximum profit for a long call is essentially unlimited above the strike price because UTX can continue to rise. The maximum loss — should UTX be trading below $82.50 at May expiration in about 53 days — is capped at 100% of the $2.15 premium paid. Breakeven at expiration is $84.65, or the strike price plus the debit paid.
The rationale: There has been much talk about the proposed merger between Goodrich Corp. (NYSE:GR) and UTX as of late. Goodrich shareholders voted unanimously to approve the deal that would see the company become a wholly owned subsidiary of UTX. Despite low profit margins, the company has demonstrated its strength through revenue growth and an increase in its net income, just to name a few.
From a technical perspective, the stock just recently surged up to just above $87 before selling off down to a support area around $82. A bullish sign that might indicate the stock wants to resume its uptrend would be if it could trade above Friday’s high of $82.29. This would effectively trigger a reversal sign from a support area. Once in the trade, look for the stock to test recent highs around $87.
Hopefully this trade idea lives up to the saying “united we stand” and not “divided we fall.”
As of this writing, John Kmiecik does not own any shares mentioned here.