American Express Company (NYSE:AXP) had its “aha” moment late this May. Prior to that, AXP stock had slid 7% and was knocking on a neckline that needed to hold. It did, and with a double bottom, AXP took off like a rocket.
Here it is 12% higher and with room to run. This late in the rally, potential traders are likely to hesitate going long now — $86 per share is pivotal.
Today, I will share my way of betting long with nothing out of pocket and with plenty of room for error just in case AXP has run out of steam.
What helps American Express is that the financial sector in general benefited tremendously from the hope that the Donald Trump presidency brought about. Trump promised to unshackle the sector from red tape, so that they go on with their business of funding growth.
This is in addition to the U.S. Federal Reserve’s promise of higher rates, which will provide a lift to the sector stocks. The Financial Select Sector SPDR Fund (NYSEARCA:XLF) is up 27% since the elections.
Click to Enlarge With a price-earnings ratio of 15, AXP stock is not expensive in absolute terms. And relative to its competitors it’s also a bargain. Both Visa Inc (NYSE:V) and MasterCard Inc (NYSE:MA) carry a P/E twice that of AXP.
Aside from its famous flub with the Costco Wholesale Corporation (NASDAQ:COST) account, management is a proven performer. AXP’s future should be rosy as long as equity markets in general stay bullish. Its income stream depends on consumer spending and electronic transactions, and in an era where shopping is becoming heavily web-based, this is only likely to get better for American Express and other transactors.
Yes, there are alternatives and new entrants like Paypal Holdings Inc (NASDAQ:PYPL) and Square Inc (NYSE:SQ), but I think that there will be enough business for all of them to thrive for years to come. Although it’s not expensive, I fear a little about how high expectations are now for AXP stock.
Technically, this latest breakout in AXP may be a measured move off an inverse head-and-shoulder pattern, which has much more to go. There is room to $92 just based on the extension of it. There could be draw-downs along the way, but eventually if the macro remains unchanged I expect it to get there eventually.
But I am no one to buy American Express stock and hope for a rally. I like to leave room for error, so I use AXP options instead. Furthermore, expectations for the financial sector are now top heavy. Most experts are bullish bank stocks which could create a shortage of incremental buyers.
The Trade: Sell AXP stock Jan 2018 $72.50 puts and collect $1 per contract to open. Here I have a 90% theoretical chance of keeping the whole premium for maximum gains. But if price falls below my strike then I must own the shares at that price and accrue losses below $71.50.
I can moderate the risk by using a spread instead of naked puts.
The Alternate and More Moderate Version: Sell AXP stock Jan 2018 $75/$72.50 credit put spread where I have about the same odds of success, but where the worst case is not as grave. Yet, if successful, the spread yields 15%. Compare this with buying the stock at face value near highs and without any room for error expect a 15% rally. My set ups leave a 15% buffer to account for temporary dips if they come.
Investing in stocks and options is risky business, so I never bet more than I can afford to lose.
Learn how to generate income from options 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.
