by John Kmiecik | November 11, 2013 8:37 am
Looking back at a stock’s performance can be a terrific way to gauge where the stock may be heading in the future. This approach has its flaws; namely, the future of the company and the market can be unpredictable. But here’s a trade idea that looks to take advantage of the past and hopes it can continue in the same manner in the future.
Constellation Brands (STZ) makes alcoholic beverages. The company has a market cap of close to $10 billion and has grown through acquisitions. Its second-quarter earnings were impressive — net sales came close to doubling versus a year ago. Perhaps even more impressive is that Constellation also increased its guidance for 2014, citing increasing demand and popularity of wine. The wine industry is expected to keep growing — and Constellation is the biggest wine producer in the world.
A diagonal spread involves buying one option and selling another option with a different strike and different expiration month. It is essentially a time spread or a calendar spread with different long and short strikes.
In this case, you’d buy the STZ April 2014 67.5 calls and simultaneously sell the STZ December 70 calls for a net debit of $3.60 or better.
The goal for this strategy is for STZ stock to trend slowly up and eventually help pay for the long-term call with the short-term call’s premium received. It is somewhat similar to a covered call, but instead of owning the stock, a long-term call is purchased instead. A perfect-case scenario is for the stock to be slowly moving higher and be trading right at the short call’s strike at expiration. The most that can be lost is what was paid for the spread.
Click to EnlargeSTZ stock is up about 80% year-to-date. Despite some volatility at the beginning of the year, the stock has been on somewhat of a smooth ride moving higher. What can slow this stock down? If you are thinking overhead resistance, you’d be wrong — the stock has been consistently trading at its all-time highs. This strategy is potentially a great way to capture a potential continued move higher in STZ and still limit the risk.
This process can be duplicated each month to continually help decrease the cost of the trade. If STZ stock continues to increase, so will the long calls’ intrinsic value — and the trader can keep selling a higher-strike call every expiration. Cheers!
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