Yesterday we previewed Broadcom (AVGO) earnings and detailed a bullish/ stock alternative strategy that defined risk into the print. Here was the trade and rationale, from June 1st:
Bullish/ Stock Alternative
Similar to what we detailed into PANW earnings yesterday, we can define our risk, provide upside exposure and limit risk on higher than normal volatility
AVGO (237) Sell the June 2nd weekly 235/230 put spread, to Buy the July 240/260 call spread risk reversal for 3.75
It starts with selling a put spread near term:
Sell the June 2nd 135/130 put spread at 2.00 (risking $3)
- Sell 1 June2nd 235 put at 4.75
- Buy 1 June2nd 230 put for 2.75
and then buying a call spread farther out in time.
Buy the July 125/150 call spread for $5.75
- Buy 1 July 240 call for 8.20
- Sell 1 July 260 call at 2.45
Breakeven On July Expiration – As long as the stock is above 135 on Friday, the July 140/160 call spread comes at a cost of 3.75, with the chance to make up to 16.25 if the stock is at or above on 160 on July expiration. Its break-even in that case is 143.75 with gains above and losses up to 3.75 below. However, the risk profile is different if the stock is below 135 into Friday.
Risk/Reward into Friday, June 2nd expiration – If the stock is below 135 on Friday there is added risk to the position as the put spread sold at 2.00 can lose up to 3.00. That is the maximum it can lose.
Total Risk/Reward – The most that can be lost on this trade overall is 8.75 (less than the implied move), the most that can be made is 16.25. The 8.75 is at risk if the stock is down sharply on earnings. The max gain is possible if the stock is higher than 135 on Friday’s expiration, at which point, the risk is reduced to just 3.75 out until July.
Rationale – This trade takes advantage of high implied vol in the weeklies to finance a wide call spread in July. It is a slightly more complicated trade than what we normally detail, but it’s an interesting one with fairly favorable defined risk/reward.
With the stock trading $251 this morning this trade did quite well. The short put spread will expire worthless this afternoon, and the July call spread is worth a little more than $10. With the put spread about to expire worthless, there is now only 3.75 at risk on the trade, but of course, all $10 of mark to market value is at risk. So for trade management purposes, it can either be closed today for a nice profit of more than a double, take half off and play with the house’s money between now and July expiration, or adjusted to reduce risk but stay in the game for more profits. One such adjustment would be to now turn the July call spread into a call fly, by selling the 260/280 call spread at $2. That reduces overall risk to just 1.75 on the trade and has the opportunity to make up to 18.25 if the stock is 260 on July expiration. A more aggressive adjustment would be to roll the July 240/260 call spread up to the 250/270 call spread. That roll would lock in some profits from this trade while allowing for more upside and a new price target of 270, booking more profits now than the fly idea, but risking current profits even more by going more out of the money.
Either way there are very few bad choices here as the trade worked out nicely.