Shares of Taiwan Semiconductor, also known as TSMC, have been on fire lately. But could the current TSMC stock rally need a little pause, or will it continue to slowly grind higher?
With the stock a little extended, TSMC might rally a little further. Odds are, however, that it may be close to a ceiling.
In situations like this, it's best to use a diagonal call spread. This is an advanced options strategy because it utilizes options over two different expiration periods.
The ideal scenario is that the stock rallies up to just below the short call right before the option's expiration. Selling the July 18 call at 240 and buying the Aug. 1 call at 245 would cost around $100 for each contract of 100 shares.
Maximum Downside Loss Equal To The Premium
The trade is placed for a debit, so the maximum loss on the downside is equal to the premium paid of around $100. The maximum risk is on the upside is equal to the difference between the strikes plus the premium paid. With the strikes being $5 apart, that makes the risk on the upside $600.
There is a nice profit zone between around 225 and 250, with a maximum potential profit estimated at around $400. But here's the catch: You don't want the stock to get to that zone too quickly.
In terms of risk management, it's best to set a stop loss if the stock rallied above 240. As an example, if that were to happen today, the trade might be down around $50.
Diagonal spreads are an advanced strategy and not recommended for beginner option traders. In summary, the trade has low risk on the downside and does best if the stock has a slow grind higher, rather than a sharp move upward.
TSMC Stock First In Its Group
According to Investor's Business Daily's IBD Stock Checkup, TSMC stock ranks No. 1 in its group. Further, IBD gives it best-possible marks of 99 in both its Composite Rating and Earnings Per Share Rating. Its Relative Strength Rating is a near-ideal 98.
It's important to 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.
