Earnings are slowly starting to die down, and soon all traders will have left is trading based on fundamentals and technicals. Here is a long-term trade idea that looks good from both sides and might help you turn a profit over the normally quiet summer.
Time Warner (NYSE:TWX — $59.48): Diagonal Spread
The trade: Buy the January 2014 60 calls and simultaneously sell the June 62.5 calls for a net debit of $3.30 or better.
The strategy: A diagonal spread involves buying one option and selling another option with a different strike and different expiration month. It is essentially a time spread or a calendar spread with different long and short strikes. The goal for this strategy is for the stock to trend slowly up and eventually help pay for the long-term call with the short-term call’s premium received. It is somewhat similar to a covered call, but instead of owning the stock, a long-term call is purchased instead. A perfect-case scenario is for the stock to be slowly moving higher and be trading right at the short call’s strike at expiration. The most that can be lost is what was paid for the spread.
The rationale: Time Warner is a giant in the media and entertainment businesses. It has its hand in television, films and publishing to name a few. The company announced earnings on Wednesday and earnings grew about 24% in the first quarter despite a minor drop in revenue. The company said that revenue growth from particularly its television channels help offset some declines in revenue from its magazine and studio production business.
Click to Enlarge Looking at Time Warner’s chart over the past year, the stock has been slowly climbing higher. The stock was trading around $34 in June 2012 and just closed below $60 on Wednesday. It hasn’t been a perfect trend higher, but it has been pretty close, which includes a pullback in October of last year. What better way to capture a potential continued move higher than with a diagonal spread?
This process can be duplicated if desired or possible each month to continually help decrease the cost of the trade. If the stock continues to increase, so will the long calls’ intrinsic value, and the trader can keep selling a higher-strike call every expiration.
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities.