Akamai Technologies (NASDAQ: AKAM) has seen a large burst of call buying activity recently targeting the out-of-the-money (OTM) strikes for January and February. Traders were showing their hands by favoring a strong upside bias with call volume exceeding put volume by more than five times its normal average.
In addition, the bullish setup is interesting from a technical perspective as Akamai stamped out a bullish outside reversal recently at strong previous support levels with a good jump in volume.
There are a number of ways to play a bullish setup like this in a risk managed way. We could buy the stock outright, sell puts to acquire the stock at a cheaper price, or buy a bullish call spread to participate in any upside action. Today we’ll highlight the rationale for a bull call spread.
A bull call spread is a leveraged way to get upside exposure in a stock on a risk defined basis. It is a flexible strategy that doesn’t tie up a lot of capital and gives the investor the ability to define his risk and reward (level of bullishness) through the selection of call strikes that are purchased and sold for the spread. With the stock closing today at $48.85 we are targeting the purchase of the AKAM Feb 50 Call strike and selling the AKAM Feb 55 Call strike to reduce the cost of the overall spread.
Prices on the close: Jan. 10, 2011
Buy to Open 1 Feb 50 Call = $2.70
Sell to Open 1 Feb 55 Call = $1.15
Net Debit for Spread: $1.55 (max risk in spread)
Max Reward: $3.45
Reward = 2.25 X Risk
The white line in the model above highlights the P&L curve as of today. The red line highlights the P&L curve on options expiring in February (Feb 18th). The most favorable outcome would be to see Akamai move higher quickly. As you can see, the white P&L line is sloping gently to the upside as the trade unfolds. This is because the trade is DELTA positive (meaning higher prices will help the trade). The spread is also slightly THETA negative (meaning passing time will hurt the trade by a certain degree). The trade is also positive VEGA (meaning rising implied volatility will move us to profits a little more quickly).
Akamai has an earnings release coming on Feb. 9 and with that we may see the level of implied volatility (IV) in the options continue to rise into that event. Part of my plan would be to close down this trade prior to earnings. As with any trade, our job as traders is to define our risk and stick to those parameters without fail. Good traders can be wrong 40% of the time and still print money because they stick to their risk plan. The bull call spread on Akamai puts risk and reward strongly in our favor (2.25/1) and the maximum risk is defined in advance — key ingredients in the trade decision process.
Author John Manley is an independent professional trader and instructor. He is responsible for the management of a private derivatives-based hedge fund.
