The market pulled back slightly yesterday, and I want to be prepared for a larger drop in the future with a calendar put debit spread on MGM Resorts International (NYSE:MGM).
There’s no shortage of reasons to be bearish on casino and gaming stocks like MGM. Casinos in Macau had to shut down when COVID-19 started spreading across China. Though they reopened in February, the spread of the disease was still reducing tourism.
MGM’s Grand Macau is one of the largest casinos on the tiny island, and it almost certainly lost business as a result.
And even though Macau has reopened, the city of Las Vegas remains shut down.
Why Use a Calendar Spread?
In a calendar debit spread, you buy an option that expires later than the option you sell. You want the stock to remain above the strike price for your short option through its expiration. In this case, our short option will expire on May 15, and our strike price is $11.
We want MGM to remain above $11 through May 15.
Once that position expires, you want the stock to move below your long option’s strike price. In this case, our long option expires June 19, and our strike price is $14.
We want MGM to move below $14 after May 15.
The market has been bullish lately. Despite poor earnings from JPMorgan Chase (NYSE:JPM) and Wells Fargo & Company (NYSE:WFC) on Tuesday morning, the market rallied. The slight pullback yesterday could mean a correction is on the way, but I believe investors are optimistic — perhaps overly optimistic.
The Department of Labor released new unemployment insurance claims numbers this morning, and the number of new claims is lower than last week, coming in at 5,245,000.
Investors may look at the slowing rate of unemployment claims as a sign that the numbers have peaked, but that optimistic take ignores the reality that over 20 million people have lost their jobs.
People are less likely to gamble when they don’t have money coming in.
With a calendar spread, we get to keep the full premium from our short option if investors push the market higher, and we can collect a profit on our long option when the market turns lower.
And if investors do take a more pessimistic stance on the economic situation, pushing stocks like MGM lower, traders can still collect a profit by closing this calendar put debit spread early.
A Bearish Pennant Pattern
As of this morning, MGM is sitting just below $15 per share. The stock has made an impressive recovery since hitting its low of $5.90 on March 18.
If you look at the chart below, you can see that the stock has been rising in a “pennant” pattern. During a bearish trend, this technical formation can appear before another drop, and I think that’s possible with MGM.
Daily Chart of MGM Resorts International (MGM) — Chart Source: TradingView
But fundamental issues could also push MGM lower. The company reports earnings on April 27, and its first quarter was marred by the closures in Macau, which were followed by closures in Las Vegas.
As I mentioned above, the calendar debit spread has an added advantage because if the stock doesn’t fall before the short option expires, traders get to keep the full premium from selling the option. Then they can close the long option for a profit as the stock falls.
But traders can also close the trade early if MGM’s earnings push investors out of the stock.
Using a spread order, buy to open the MGM June 19th $14 put and sell to open the MGM May 15th $11 put for a net debit of about $1.65.
Note: Be sure you are buying to open the monthly MGM options that expire on Friday, June 19, 2020. Be sure you are selling to open the monthly MGM options that expire on Friday, May 15, 2020.
About Put Debit Spreads
A debit spread is simply a way to lower the cost of buying options, as the option that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this put debit spread is a way to lower the cost of buying bearish put options. Many brokers will require the use of margin and/or a set amount of reserved capital to execute a debit spread; contact your broker directly for specific requirements.
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