A Biden Trade Could Deliver a 194% Gain
Trade summary: A bull call spread in Palantir Technologies Inc. (NYSE: PLTR) using the November $13.50 call option which can be bought for about $1.60 and the November $16 call could be sold for about $0.75. This trade would cost $0.85 to open, or $85 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $85. The maximum gain is $165 per contract. That is a potential gain of about 194% based on the amount risked in the trade.
Now, let’s look at the details.
Palantir Technologies Inc. builds and deploys software platforms for the intelligence community in the United States to assist in counterterrorism investigations and operations.
It offers Palantir Gotham, a software platform for government operatives in the defense and intelligence sectors, which enables users to identify patterns hidden deep within datasets, ranging from signals intelligence sources to reports from confidential informants, as well as facilitates the handoff between analysts and operational users, helping operators plan and execute real-world responses to threats that have been identified within the platform.
The company also provides Palantir Foundry, a platform that transforms the ways organizations operate by creating a central operating system for their data; and allows individual users to integrate and analyze the data they need in one place.
Bloomberg reported that “Palantir Technologies Inc. surged [recently] on speculation that Democrat Joe Biden — nearing victory in the U.S. presidential race — would rein in military spending and spur demand for the company’s lower-priced surveillance technology.
The stock rose as much as 26% last week, the most since its direct listing in September as many investors expect defense spending would be cut under a Biden administration.
Palantir, which was co-founded by Peter Thiel, counts the U.S. Defense Department among its largest customers and could benefit from budget cuts because its software often costs less than similar offerings from traditional defense contractors.
Its shares could also be benefiting from short sellers exiting their positions as the stock rises, according to Melius Research analyst Carter Copeland, who called the stock’s volatility “stunning.”
“Given that the rest of the defense and industrial security complex hasn’t reacted in the same way, one would conclude there’s an element of short covering here,” he said in an interview.
About 6% of Palantir shares that are available to trade are being sold short, according to the latest data from financial analytics firm S3 Partners. That’s down from about 9% on Oct. 28.
A Specific Trade for PLTR
For PLTR, the November options allow a trader to gain exposure to the stock. This trade will be open for about three weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A November $13.50 call option can be bought for about $1.60 and the November $16 call could be sold for about $0.75. This trade would cost $0.85 to open, or $85 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $85.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in PLTR, the maximum gain is $165 ($16- $13.50= $2.50; 2.50- $0.85 = $1.65). This represents $165 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $85 to open this trade.
That is a potential gain of about 194% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying PLTR could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.