What can you do if a stock you’re following suddenly plummets? It’s extended to the downside, but will it fall even further? If you’re an option trader, you have a strategy for that outlook.
Here is a trade idea that is not necessarily bearish but can still profit even if the stock reverses and tries to move a little higher again.
CF Industries (NYSE:CF) is a fertilizer maker whose stock fortunes have changed in the past few weeks. The stock had just broken through its 200-day simple moving average to the upside and looked to be moving higher when suddenly the stock started falling — and the bleeding hasn’t stopped.
How to explain the share price decline? Well, inventories have been rising due to decreased demand, especially from India. In fact the company has had to cut production because inventory is above its five-year average. Adding to the problems, demand this spring has simply not been there so far.
Here’s an options play that will profit if CF continues its recent doldrums: Sell the April 200/205 call credit spread (selling the April 200 call and buying the April 205 call) for 0.70 or better.
The maximum potential profit for this trade is $0.70 if CF is trading below $200 at April expiration — both call options would expire worthless. The maximum loss is $4.30 ($5 – $0.70) if CF is trading above $205 at April expiration. Breakeven is $200.70 at April expiration.
Click to EnlargeHow far could the stock continue to drop? It really depends on whether support at $190 holds. If that area gives way, the stock will probably continue to drop. If the stock attempts to rally, there is some resistance around $195 that had been previous support — that area may try to keep the stock from moving higher. Finally, the $200 area has acted as support and resistance for the stock and may do so again.
In other words, there are several scenarios that can take place — and plenty of them have the credit spread expiring worthless … exactly what we’re looking for as sellers here.