With the market uptrend under pressure, I like to take a look at defensive names that are still trading above their 50-day moving average. One such name is Merck stock.
Despite the low ratings, I like the fact that Merck stock crossed above the key 200-day line. Let’s take a look at a reasonably conservative option strategy known as a bull put spread.
To execute a bull put spread, an investor would sell an out-of-the-money put and then buy a further out-of-the-money put.
Merck Stock: Bullish Option Trade
With Merck’s 200-day moving average around 78.66, a bull put spread could be placed with the short put at 77.50 and the long put at 75.
Using the June 18 expiration, this spread was trading for around $0.60 Monday. That means a trader selling this spread would receive $60 in option premium and would have a maximum risk of $190.
That represents an 31.58% return on risk between now and June 18 as long as MRK stock remains above 77.50. If Merck stock closes below 75 on the expiration date, the trade loses the full $190.
With earnings set for the end of July, there is no earnings risk with this trade.
The break-even point for the bull put spread is 76.90, which is calculated as 77.50 less the 0.60 option premium per contract.
This bull put spread trade has a delta of 16 which means it is a similar exposure to owning 16 shares of MRK stock. Although this exposure will change over time as the stock price moves.
A simple stop loss for a trade like this would be if MRK stock dropped back below the 200-day moving average.
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, 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
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