This Trade Could Deliver 244% in Gains on $145 In Risk
For traders, open possible goal could be managing risk. Recent news offers an example of how risk can be limited while potential returns could be relatively high. Business Wire reported the news: “Datadog (Nasdaq: DDOG), the monitoring and analytics platform for developers, IT operations teams and business users in the cloud age, announced a new integration with Microsoft Azure DevOps.
Users can pull in events, derive metrics from their continuous integration pipelines, and correlate this information with real-time data from their entire stack in Datadog.
In addition, teams can set Datadog monitors as gates in their Azure DevOps deployment pipelines, enabling them to detect and abandon bad releases automatically before users are impacted.
Companies are increasingly adopting continuous integration and continuous deployment best-practices to improve the speed and agility of their developer operations.
As part of this, many teams rely on services like Azure DevOps in order to release more frequent, smaller updates to their code. As updates proliferate, monitoring this activity in context with application performance data becomes critical.
Without this visibility, determining a root cause and fixing bugs in dynamic environments can be very time consuming, resulting in extended outages.
“We’re excited that users will no longer need to jump between tools to monitor how deployments might be impacting their applications,” said Steve Harrington, Product Manager at Datadog.
“With the ability to stop Azure DevOps deployments automatically based on issues detected in Datadog, this integration provides a powerful tool for mitigating or preventing downtime altogether.”
In addition to troubleshooting deployments, managers can also use this integration to understand the efficiency of their devops processes.
Datadog generates metrics to help track Azure DevOps events, so users can see how often builds are completing or failing, the frequency of code commits, and the duration of work items. This data provides useful feedback for teams to track and improve their workflows as they implement Agile methodology.”
The stock moved higher, although the news seems unlikely to be the primary cause of the move.
As traders, there is no need to understand the reason for the move. As long as risk is limited, the trade could be attractive.
A Trade for Short Term Bulls
As with the ownership of any stock, buying DDOG 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.
A Specific Trade for DDOG
Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For DDOG, the January 17 options allow a trader to gain exposure to the stock.
A January 17 $40 call option can be bought for about $2.40 and the January 17 $45 call could be sold for about $0.95. This trade would cost $1.45 to open, or $145 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 $1.45.
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 DDOG the maximum gain is $3.55 ($45 – $40= $5; $5 – $1.45 = $3.55). This represents $355 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $145 to open this trade.
That is a potential gain of about 244% in DDOG based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.