Adobe stock plunged nearly 5% more Tuesday and broke through its key 50-day moving average. Even though the software icon beat earnings and raised its outlook, investors remain wary.
For one, Adobe's generative artificial intelligence initiatives haven't yet delivered expected returns, drawing criticism from some Wall Street analysts. Further, Adobe faces heightened competition in creative software from Canva and generative AI startups.
With that in mind, Adobe is a good candidate for a bearish option trade. Today, let's look at a bear call spread that assumes Adobe will struggle to get back above the 400 level between now and mid-July.
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call. The strategy can be profitable if the stock trades lower, sideways, and even if it trades slightly higher, as long as it stays below the short call at expiration.
Making The Bear Call Spread Work
A bear call spread with a July 18 expiration on Adobe stock using 400-405 strike prices can be sold for around $1.30. With a single contract of 100 shares, traders selling the spread would receive $130 in option premium which is also the maximum possible gain.
The maximum loss would be $370. That represents a potential return of 35% between now and July 18.
The spread will achieve the maximum profit if Adobe stock closes below 400 on July 18, in which case the entire spread would expire worthless, allowing the trader to keep the $130 option premium. The maximum loss will occur if Adobe closes above 405 on July 18, which would see the premium seller lose $370 on the trade.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy, and you always know the worst-case scenario in advance.
A stop loss could be set if Adobe trades above 400, or if the spread value rises from $1.30 to $2.60.
Adobe Stock: No. 3 In Its Group
Bear call spreads can be a good way to potentially generate some income while the market consolidates recent gains.
According to Investor's Business Daily's IBD Stock Checkup, Adobe stock ranks third in its group. It also has a Composite Rating of 59, an Earnings Per Share Rating of 91 and a Relative Strength Rating of 21.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a masters in applied finance and investment. He specializes in income trading using options, and is conservative in his style. He also believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ.
