The market pushed higher on Monday morning, and yesterday the market was slightly higher until just before the close. The bullishness from the plans to open the economy wasn’t enough to push the S&P 500 above resistance at 2,880, but investors didn’t push the market too much lower.
With the rally on hold, I’d like to recommend a position that takes advantage of the market’s ambiguity: a calendar call credit spread on the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD).
Neither Bearish Nor Bullish
With a calendar call credit spread, you are selling an option that will expire sooner than the long option you buy on the same underlying stock. The short option in the trade should be worth more than the long option. Since you are selling an option worth more than the option you buy, you will collect a credit.
The wonderful thing about this position is that it isn’t exactly bearish or bullish. In this case, we’ll be selling a call option that expires on May 22 with an out-of-the-money strike price relatively close to the current price of LQD.
Then you will buy a long option that expires on June 19 with a much higher strike price, so it is even farther out of the money.
Ideally, the short option will expire worthless, meaning LQD won’t rise above our short strike price before May 22. You would get to keep the full premium from selling this trade after it expires worthless.
Then you’ll continue holding the long LQD option, waiting to see if it rises. If it doesn’t, this option will expire worthless, but you will still have a profit from selling the short option.
If LQD does move higher, your long option will rise with it, and you can collect additional income by selling the option for a higher price.
LQD is an ETF that tracks lower-risk corporate bonds, but I don’t think “lower risk” is good enough right now.
Companies are at greater risk of going bankrupt in this market, and bankrupt companies will default on their debt, failing to meet their obligations and leaving investors with worthless bonds. Even these “lower risk” bonds are a gamble, and I don’t think investors will push into corporate bonds for safety if there is another downturn.
Right now, the market is consolidating after a bullish run higher. LQD is drifting lower, but it’s moving slowly. Its prices are relatively stable at current levels. If the economy looks like it’s in a better place in a month, but stocks are still too risky, corporate bonds may be appealing. Traders wouldn’t want to miss out on a lucrative bullish opportunity, and this trade is the best of a bearish and bullish position.
Daily Chart of iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) — Chart Source: TradingView
As I said before, the short option in this trade will have a strike relatively close to LQD’s current levels. I am setting it at $132.50. LQD has formed short term resistance at $132, and I expect it to remain below that level through most of May.
Our long option strike price is $155. I don’t expect LQD to rise to that level, but if this exchange-traded fund (ETF) recovers in June, rising to its pre-crash highs, the long option could gain a little bit of value.
The primary purpose of this trade is to collect income in the short term, any other profits are a bonus.
Using a spread order, sell to open the LQD May 22nd $132.50 call and buy to open the LQD June 19th $155 call for a net credit of about $0.30.
Note: Be sure you are selling to open the weekly LQD options that expire on Friday, May 22, 2020. Be sure you are buying to open the monthly LQD options that expire on Friday, June 19, 2020.
About Call Credit Spreads
A call credit spread is typically a bearish position that involves writing (selling to open) an option and simultaneously purchasing (buying to open) an option at a different strike price in the same underlying security. The position, or leg, of the spread trade that you sell gives you a cash credit to your trading account. The option you buy limits your risk and lowers your margin requirement for the trade.
InvestorPlace advisor Ken Trester also brings you Power Options Weekly, which delivers 5 new options trades and his latest trading advice to you each Friday. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.