Scooping up a cheap defense stock trading near a 52-week low while reducing the risk using options

Published Wed, Feb 7 202410:32 AM EST

It might be surprising that as geopolitical tensions and the risk of a wider regional conflict in the Middle East rise, defense stocks have been lagging on the sidelines. Despite reporting better than expected earnings, investors sold Northrop Grumman (NOC) and Lockheed Martin (LMT) after earnings on the back of an uncertain outlook and guidance. With defense stocks trading closer to their 52-week lows, I believe that this presents an attractive risk/reward opportunity to potentially add some of these defense stocks to your portfolio. For the past year, NOC has largely traded within a range from $430 to $480 and its recent earnings announcement triggered a slide to the lows. The stock has since bounced off those lows and starting to show strength and now looks to close the gap at $463 before potentially reaching the $480 top of the trading range. Currently, analysts are expecting about 6% EPS growth this year on the back of 5% revenue growth, which is modest. However, this is reflected in the valuation at 18 times forward earnings. NOC is inexpensive relative to both itself and the market. With these types of valuations, the downside is limited, and the upside remains sizable, especially given the propensity for defense stocks to outperform during escalations of war. The biggest risk to NOC is its ability to navigate supply chain costs and budget overruns, which recently dented its recent quarter earnings. The trade The implied volatility rank on NOC is currently sitting at 23%, which indicates that options are neither cheap nor expensive. In these scenarios, my preference is to own the upside by purchasing options but using a vertical spread structure to reduce my overall risk and capital required. I'm buying to open the March 22 $450/$475 call vertical at $8.15 Debit. This means that I am: Buying March 22 $450 Calls @ $10.85 Debit Selling March 22 $475 Calls @ $2.70 Credit This strategy would risk a total of $815 per contract if NOC is below $450 on the March 22 expiration and potentially gain $1,685 per contract if NOC is above $475 at expiration. DISCLOSURES: (none) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL'S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.