Trade of the Day: Abercrombie & Fitch (ANF)

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Clothing retailer Abercrombie & Fitch Co. (ANF) has been steadily climbing higher and looks to be making a move back toward its February highs. As such, it’s a prime candidate for one of my favorite trades: the put credit spread.

Here is the information you need to know to open today’s spread:

  • Underlying stock — Abercrombie & Fitch (ANF)
  • The stock is currently trading at around $22.
  • Trade Type — Put credit spread
  • This position generates about a 10% return on margin for a three-week holding period. Your maximum risk is $270 per contract.

In a credit spread, you “sell to open” (write) one option and, at the same time, “buy to open” another option on the same stock, but with a different strike price. By doing so, you’re getting paid to open the position, as the cash credit you get from selling the one option is greater than what you spend from buying the other option.

The purpose of the long option is to limit your risk and lower your margin requirement for the trade. For maximum profits, you want both options to expire out-of-the-money. (Since I am bullish on Abercrombie, I am recommending ANF puts for this particular credit spread.) But, either way, you will keep the cash option premium you received when you opened the position.

Making the Trade —Use a spread order to sell to open the ANF May Week 5 $20.50 Put (ANF150529P00020500), and buy to open the ANF May Week 5 $17.50 Put (ANF150529P00017500), for a spread credit of about 30 cents or more.

Note: There are several expirations available in the May series, so be sure you are opening the Week 5 puts that expire on Friday, May 29, 2015.

If you haven’t traded credit spreads before, talk to your broker first. You will typically need level 4 clearance in order to place two-legged trades in your account — i.e., set up each part of the trade in one transaction.

You will also be required to have enough cash or margin in your account to “cover” the underlying shares for every option contract you write. We are not actually looking to buy the shares, but it is possible if the ANF May Week 5 $20.50 put expires in-the-money…at which point you’d have to purchase 100 shares at $20.50 for each credit spread contract.

With this in mind, I recommend that you use an auto-stop order to close this position if ANF trades below $19.90 prior to expiration. Abercrombie is scheduled to report earnings on May 28, the day before these puts expire, so it is a position to watch closely.

For those who would like more background on credit spreads before opening this position, be sure to check out my free report, Wall Street’s Most Powerful Trading Secret.

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