A Smart Bet on Johnson & Johnson?
If you need to get conservative, here is one way to do it.
On Friday we noticed unusual option activity in Johnson & Johnson . The biggest trade of the day was the sale of 22,500 Jan. 67.5 puts for $0.46, and the simultaneous purchase of the same number of Jan. 60 puts for $0.07.
What is this trader trying to do?
Well, this is a bullish trade done for a net credit of $0.39 that bets JNJ will be above 67.5 at expiration. On Oct. 16, JNJ reported better than expected earnings and raised forward guidance, which has sent the stock up over 4 percent since then. (Read More: J&J Profits Beat Expectations.)
This has created a bullish chart pattern with strong support at 67. By selling the 67.5 puts, this trader is saying that it is a level they are willing to buy the stock at. The trader has hedged this sale by buying the 60 put, which reduces the risk and margin required for the trade by getting them out of a long stock position at that level.
This trade is a good example of how to use options to get long exposure to a stock. This trade will require the trader to put up $7.11 in margin, versus the 71.86 it would take to buy the stock now.
As long as JNJ does not drop over 6 percent between now and January expiration, this spread will realize its full value and return an annualized 22 percent. However, unlike a stock position, it is possible to lose the entire amount invested in this spread if JNJ drops below 60, which would be 16 percent below Friday's close.
(Read More: 5 Hedge Fund Favorites to Buy This Fall.)
For traders looking to get long JNJ, but who do not want to chase the stock, this is a good alternative that can make money in an up, sideways, or modestly down market. As long as the position is sized appropriately, and you are willing to buy JNJ at 67.5, consider putting on this spread instead of buying the stock.
Brian Stutland is the President of Stutland Equities and a contributor to CNBC's "Options Action."
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