Market momentum is Red. It might not feel like it after today’s rally, but pay close attention to volume ahead of this earnings season. We’re coming off another long holiday weekend, and investors need to assess the conditions ahead of next week. In addition, we have earnings AND CPI data ahead of the Fed’s next meeting. Expect some wild swings, and be conservative.
Okay, It’s time to talk about General Mills (GIS). The cereal manufacturer – behind brands like Honey Nut Cheerios and regular old Cheerios – has consistently bounced to new 52-week highs. Despite concerns about inflation, packaging, and high production costs, GIS keeps increasing.
The moves for GIS come as most of the market trades under its 50-day moving average. The general rule of momentum is that stronger stocks tend to move higher… While weaker stocks tend to move lower over time.
Right now, buying 100 shares of GIS would cost roughly $7,560. That seems like a trade for a rich man. But what about buying GIS and trading it like a “poor man?”
In The Money
One of the great ways to trade stock like GIS is to use the leverage of options. Rather than speculating on calls that are trading at a higher strike price than today’s price of $75.51. You can purchase an “In the Money” Call for the stock. The In-the-Money (ITM) trade consists of buying the right to purchase a stock at a price lower than today’s levels on or before a specific date.
For this example, we’ll use the GIS $72.50 call for July 15, 2022, which is $3.25 per contract. The breakeven price for this contract by NEXT Friday would be $75.75. That means we have roughly 15 cents of time baked into this contract. You are buying IN the money.
If you only buy the contract, you need the stock to move above that breakeven level to make any money by next Friday. And according to Options Profit Calculator, the odds of this are $45.1%.
Not bad. Plus, you’ve defined your risk by knowing that you have the right, but not the obligation, to buy 100 shares at $72.50 on or before next week.
But it’s not the greatest odds either. If it goes higher, I could buy the stock and have a 50-50 shot of making money. So, what if you do something called a Poor Man’s Covered Call?
Making Money The Poor Way
A traditional covered call consists of an investor owning 100 shares of a company’s stock and then selling a call at a strike price out of the money. For example, you might own 100 shares of GIS. If you sell the $77.50 call for next Friday, you’d only receive $0.25 per share or $25.00 total. That is on top of roughly $7,561 on the existing stock that you own.
That’s not much of a return, is it? To put up that sort of money for $25 is silly. But what if you own the In-the-Money and then sell the $77.50 call for $25.
You can write this call, and you end up defining your risk at $300 because the spread is ($325 minus $25). You now have more than a 50% chance to make money (remember the stock is 50% always) You also define your upside on this at $77.75 by next Friday, and your breakeven at roughly $75.50.
You effectively put up a margin of $300 for this momentum stock to continue climbing, and your maximum return is $200. So, what sounds better? Using just $300 for an upside of $200… Or having to put up $7,551 for a shot at $224?
The answer is the former. Trade like a poor man.