An Innovative Idea Could Help Traders to a Triple Digit Gain
Trade summary: A bull call spread in Textron Inc. (NYSE: TXT) using the April 17 $35 call option which can be bought for about $2.27 and the April 17 $40 call could be sold for about $0.85. This trade would cost $1.42 to open, or $118 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 $142. The maximum gain is $358 per contract. That is a potential gain of about 152% based on the amount risked in the trade.
Now, let’s look at the details. Some news stories can seem inconsequential but can attract a trader’s attention to a stock that has an interesting chart setup.
The news in this case, as ACBJ reported, is that “Textron Aviation announced “a new program designed to boost an important — and aging — segment of its production workforce.
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The local division of Textron … partnered with the International Association of Machinists and Aerospace Workers and WSU Tech on a new, two-year apprenticeship program to train tooling workers.
Tooling covers everything from hand-held tools to large assemblies that help support the company’s manufacturing of Beechcraft and Cessna aircraft.
And it’s a critical segment of the workforce at Textron Aviation that is aging rapidly, as company officials said more than 80 percent of the employees doing that type of work will be eligible for retirement in the next five years.
And it’s an area of expertise that evolved right alongside the aircraft the company builds.
“As our manufacturing expertise has advanced, so has our tooling,” said Maggie Topping, senior vice president of human resources and communications.
The new program will have students paid as company employees and will have the cost of their training covered by the company.
Topping said the first class of 15 students will begin on March 23 and, thanks to the partnership with WSU Tech and the union, will have the opportunity to learn in the classroom and on the factory floor.
Students will spend two days a week at WSU Tech and three in the company’s various production plants, where mentors from within Textron Aviation will help train them and pass along the critical tribal knowledge built up on tooling over the years.
“This is a new path to a long, successful career,” Topping said during a press event at the company’s east Wichita campus.
Textron Aviation employs around 9,000 people in Wichita.”
This news simply pointed to the chart. TXT, like other stocks has been moving lower. The daily chart shows that TXT has fallen in line with the broad market.
The weekly chart puts the recent move into perspective. The decline pushed the stock out of the lower edge of a trading range and the stock has now met the price target that pattern identified.
Patterns for a trading range are found by extending the depth of the range from the breakout level.
A Specific Trade for TXT
For TXT, the April 17 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An April 17 $35 call option can be bought for about $2.27 and the April 17 $40 call could be sold for about $0.85. This trade would cost $1.42 to open, or $142 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 $142.
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 TXT the maximum gain is $3.58 ($40- $35= $5; $5 – $1.42 = $3.58). This represents $358 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $142 to open this trade.
That is a potential gain of about 152% 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 TXT 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 usually 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 has 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.