Many times it is beneficial to set up credit spreads with as little time as possible. But like most strategies in option trading, there are tradeoffs. A longer expiration usually translates to a bigger premium. Here is a trade idea on Dollar General (DG) that sacrifices time for a greater profit potential on a bullish stock.
Dollar General (DG — $60.57): Put Credit Spread
The trade: Sell the DG Feb 55/57.5 put credit spread (selling the Feb 57.5 put and buying the Feb 55 put) for 55 cents or better.
The strategy: The maximum potential profit for this trade is 55 cents if DG stock is trading above $57.50 at February expiration. The maximum loss is $1.90 ($2.50 – $0.55) if DG is trading below $55 at February expiration. Breakeven is $57.05 at expiration based on a credit of 55 cents.
The rationale: There are signs that the economy is improving, but you still hear plenty of stories that contradict that. So is it any wonder that discount equities such as DG stock are still doing extremely well? Low price points were key for holiday sales, and that trend looks like it might continue into 2014. Dollar General last announced earnings at the beginning of December, and in that report showed sales that improved more than 10%. Same-store sales were up 4.4% and earnings per share increased as well. In fact, this last quarter marked the 23rd quarter in a row that Dollar General’s customer count and what they spent increased.
If that isn’t enough proof that the economy might still be hurting, I don’t know what is.
Click to Enlarge DG stock has been on quite a roll during the last year. It has gone from around $44 to where it is currently trading, at just over $60. Yes it has had a few drops along the way, but it has found its way back to higher ground every time over the last year.
This credit spread trade idea has options that expire in just more than 30 days, which might be a little longer than desired for selling premium, but it allows a greater profit potential than a spread that expires in a shorter time frame.
What also allows a greater profit potential is that the implied volatility of DG’s options is currently higher than historical values making the options somewhat overpriced.
Since DG stock gapped on its last earnings announcement, it has not even traded below $58, which is above the sold strike. If that trend continues — or the trend of DG stock making new all-time highs, like it did a few sessions ago, continues — there might be some more spending cash in your future!
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities. Get a free trial of John’s live options trading room here.