Palo Alto Networks Inc (NYSE:PANW) was once a highflier, but it recently has undergone a massive correction. As a result, PANW stock left a giant open gap above on the daily chart.
Therein lies the opportunity.
Markets like to fill open gaps, especially ones of this size. There are exceptions, of course, but in this case there wasn’t a drastic change in outlook to warrant an absolute lid above PANW stock at these levels. Therefore it is logical to expect that markets will eventually fill all or part of the gap above.
Fundamentally, Palo Alto Networks is not cheap, but the analyst expectations are unevenly distributed more bearish than bullish. This reduces the likelihood of further disappointment. And if there were to be a ratings change, it more likely would be an upgrade rather than a downgrade.
Technically, PANW stock is in a descending channel, setting lower highs and more recently knocking on a floor board. The problem is that if the board breaks, bears will overshoot lower and retest the double digits.
The $105 per share has been pivotal since 2014, so the bulls are not likely to let it go without a decent fight.
How to Trade PANW Stock
The Bet: Buy the Sep debit call spread for $1.75 per contract, which would be my maximum potential loss. If Palo Alto rallies past my spread before expiration, I stand to more than double my money.
Usually I like to mitigate my risk. With PANW shares, I can eliminate my out-of-pocket expense by selling downside risk, but only if I see value areas that are likely to hold. The idea is to find proven support levels and sell risk below them.
Recently I shared a trade that yielded easy profits, and without much trouble, even though PANW stock traded violently of late. Today I will mirror the trade to raise potential income that would offset the cost of the calls I buy.
The Bank (Optional): Sell the Dec $65 put and collect 60 cents per contract. This trade alone has a 90% theoretical chance of success, but I have to be ready to be put Palo Alto stock at $65 if it falls below it. Otherwise I can sell it as a spread to cap my risk size.
If I take both trades, then I would be long PANW stock for no out-of-pocket risk and months for the stock to fill the gap above. I am not required to hold either of these trades through expiration, so I can close them at any time for partial gains or losses.
E-mail sellspreads@gmail.com with questions or join me to learn more about options in a personal 1on1 webinar here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
