Tuesday's pullback saw some carnage, but Square stock and others did manage to close off their lows after finding support at logical areas. If you think the "buy on the dip" mentality will hold, you may be looking to increase exposure. Here's a defined-risk option trade for SQ stock if you think the support will hold over the next few weeks.
Support For SQ Stock
Square has been rangebound since February but is holding up well on the chart. Last week, SQ stock bounced strongly from its 50-day moving average line. After Tuesday's action, it looks like it's getting support around 250.
Square stock has impressive ratings with a highest possible Composite Rating of 99, an EPS Rating of 96 and an RS Rating of 86 even during its consolidation. It's the top ranked stock in the Finance-Credit Card/Payment Processor group.
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Traders wanting to take some bullish exposure into earnings can look at a bull put spread. As a reminder, for a bull put spread you sell an out-of-the-money put and buy a further out-of-the-money put at the same time.
Bull Put Spread Setup
Here's the bull put spread I looked at on SQ stock. Sell the 255 put and buy the 250 put both with an Aug. 20 expiration.
Monday, this spread was trading for around $2. It seemed to me that Square stock was due for a pullback after its strong move last week. It was a little more dramatic due to the market overall. At Tuesday's close the bull put spread on SQ stock traded around $2.60. That means a trader selling this spread would receive $260 in option premium (a little more than Monday because of the pullback). That makes the maximum risk $240.
The ratio gives you a 108% return on risk between now and Aug. 20, as long as SQ stock gets back above 255.
If Square stock closes below 250 on the expiration date the trade loses the full $240 risked. Square stock is vulnerable on this trade right now, since it dipped below 250 on Tuesday. That's why the return on risk is a little higher. If it lost support at 250, you could either close the trade, adjust or hedge.
The break-even point for the bull put spread is 247.40 which is calculated as the lower strike of 250 less the $2.60 option premium received per contract.
Earnings for SQ stock is estimated for around August 6, so this trade has earnings risk.
Remember options are risky. 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, 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
