Genuine Parts, Monday's IBD Stock Of The Day, recently broke out to a new high. Investors who think GPC stock will continue to rally and don't want to risk significant capital can use long call options rather than buy the stock outright.
This can be a good way to protect precious capital in these volatile markets.
According to IBD Stock Checkup, GPC stock ranks No. 1 in its group and has a Composite Rating of 97, an EPS Rating of 89 and a Relative Strength Rating of 95. The giant in replacement parts for the auto and industrial markets is breaking out of a flat base with a 165.09 buy point. The 5% buy zone goes up to 173.34. Genuine Parts reported Q3 results on Oct. 20.
A call option is a contract between a buyer and seller. The contract gives the buyer the right to purchase a certain stock at a certain price (strike price) up until a certain date (expiration date).
One of the benefits of call options is that they provide leverage. Of course, this can be both a good and a bad thing. Assuming an investor wanted to buy 100 shares of GPC stock, they would have to invest around $17,200 at the current price.
Instead, the investor could gain a similar exposure using a fraction of the capital by buying a call option.
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GPC Stock: Setting Up A Call Option Trade
One call option gives the investor exposure to 100 shares. If an investor were to buy one GPC 170 call option expiring Feb. 17, he or she would only need to invest around $1,200 rather than $17,200.
The break-even price for this call option is equal to the strike price plus the premium paid. So this would make the break-even price at 182.
The most the trade can lose is the premium paid of $1,200, which would occur if GPC finished below 170 on Feb. 17 next year.
Using options in this way can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
Savvy traders can further reduce the risk by selling an out-of-the-money call, turning the trade into a bull call spread.
For example, selling the Feb. 17, 190 call in addition to buying the 170 call would reduce the trade cost by around $400. But this spread trade would also limit the profit's upside if the actual stock shoots above 190.
A stop loss could be set if GPC stock drops 7% to 8% from the entry point.
Please remember that options are risky, and investors can lose 100% of their investment.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
