What else can be said about Square Inc (NYSE:SQ) at this point? When SQ stock price was at its highs in 2017, shares were up a jaw-dropping 250% on the year. Ultimately, Square stock ended with gains of “just” 155% for 2017.
2018 hasn’t been a disappointment either, with the SQ stock price already up 50%. While the gains seem ridiculous, there was an interesting options trade recently that tips its hand to more potential upside.
The SQ Stock Options Trade
On Mar. 19, someone bought 33,000 call options. This wasn’t a low-premium “lotto ticket” trade looking to play a big rally for cheap. With SQ stock price trading near $55, this person bought 33,000 $40 strike calls expiring in September.
These units were $15 in the money and required a gigantic premium. In fact, the buyer paid $55.6 million for this particular trade.
What does this trade imply? There’s no other way to frame an outright call purchase: the buyer is clearly bullish. However, by buying such deep in-the-money calls, they are basically looking to capture the upside but only pay about one-quarter the price. They paid $16.85 per share (or $1,685 per contract because each call option represents 100 shares).
So to control 100 shares, the buyer paid $1,685 rather than the ~$5,500 it would’ve cost to buy 100 shares on Mar. 19. The upside here is obvious: for the price of 100 shares of Square, we can buy three of these contracts, effectively controlling 300 shares for the same price.
The downside is that we paid $16.85 per share at $40 per share, meaning our breakeven is actually $56.85 (excluding commissions). That’s the trade-off by putting up less capital in March, to ride any potential gains higher until September.
Please note that the leverage works both ways. A rally to $65 would lead to explosive gains. The contracts would trade for at least $25.00, ($65 price – $40 strike price = $25), giving the trader a minimum paper gain of $8.15 per share. That’s a near-50% return on the $16.85 per share they plunked down on the trade.
But if SQ stock tumbles, the trader is on the hook for all of those losses as well. The max risk is $16.85 a share, which only happens if SQ stock price closes below $40 on September expiration.
Trading Square Stock
The daily chart below shows the bullish tone that Square stock has set over the past year. In purple, I’ve highlighted the strike price for the bullish options trade outlined above. You’ll also notice the strong trend line of support (in black) that the SQ stock price has respected over the past year.
Click to Enlarge
Even in February, when the rest of the market was under pressure, Square stock held onto this line, refusing to close below it. With Friday’s 6% fall, shares are quickly fading into support. As of now, there’s plenty of that just below current prices.
$50 was previous resistance after Square stock went on its “blow off top” run in November. That level could now act as support, although if the broader market remains under significant pressure, I wouldn’t expect this support to be very strong. The $47.50 area (blue line) is likely to be strong support. Plus, the 50-day moving average is just below this level, which should also act as support.
Below that, we have trend-line support near $45 and the 100-day moving average near $42.50. Even if the selling is particularly strong, I expect trend-line support to hold up. If Square stock gets there, perhaps following in this trader’s footsteps wouldn’t be a bad way to play Square, at least for investors comfortable with options trading.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
