Shopify Options Combination Trade has a Large Profit Zone

Shopify (SHOP) is breaking out to a new high as the stock to continue to show excellent strength.

By using a combination of option strategies, we could potentially buy the stock for a significant discount, or achieve a healthy profit if the stock trades sideways.

Here’s the trade:

Sell to open the SHOP November 20 put with a strike price of $150, which was trading around $5.15 on Friday.

Then, add a bear call spread:

Sell to open the SHOP November 20 call with a strike price of $195, which was trading around $6.10 on Friday.

Buy to open the SHOP November 20 call with a strike price of $145, which was trading around $5.05 on Friday.

The sold put brings in around $515 in option premium, and the bear call spread adds another $95 in premium. In total, the combination of the two trades generates $620 in premium.

Here’s how the trade looks at trade initiation. The blue line represents the profit or loss at expiration and the purple line shows the trade as of today.

The position starts with a delta of 19, meaning it is roughly equivalent to owning 19 shares of SHOP stock. This figure will change as the trade progresses.

This is how the trade could look in around three week’s time.

Looking pretty good as long as the stock is above $155.

Possible Scenarios For This SHOP Stock Option Trade

Let’s work through a couple of scenarios of how this trade could look at expiration on February 20.

- If SHOP stock trades sideways and finishes between $150 and $195, the sold put and bear call spread will both expire worthless. The total profit will be equal to the premium received of $620.

- IF SHOP falls below $150 at expiration, we will be assigned on the sold put and will be forced to buy 100 shares at $150. However, our net cost basis will be $144.80, thanks to the $620 in option premium received. That is 15.2% below the closing price on Friday.

- If SHOP rallies above $200, the bear call spread will suffer a full loss of $500, but this will be fully offset by the $620 premium received, leaving the trade with a small profit of $120.

Not that this trade contains earnings risk with Shopify due to report on November 3rd.

Company Details

The Barchart Technical Opinion rating is a 100% Buy and ranks in the Top 1% of all short term signal directions.

Long term indicators fully support a continuation of the trend.

Relative Strength just crossed above 70%. The market has entered overbought territory.

Of 49 analysts covering SHOP stock, 34 have a Strong Buy rating, 4 have a Moderate Buy rating and 11 have a Hold rating.

Implied volatility is 62.10% compared to a twelve-month high of 80.20% and a low of 40.11%. That gives SHOP stock an IV Percentile of 59% and an IV Rank of 54.84%.

Shopify Inc. provides a multi-tenant, cloud-based, multi-channel commerce platform for small and medium-sized businesses. Merchants use the company's software to run business across various sales channels, including web and mobile storefronts, physical retail locations, social media storefronts, and marketplaces. Shopify's platform enables merchants to manage products and inventory, process orders and payments, ship orders, build customer relationships and leverage analytics along with reporting from one integrated back office. Moreover, Shopify hosts a huge database of merchant and customer interactions. Merchants leverage this transactional dataset to get meaningful insight into the sales channel growth prospects and consumer behavioral aspects. This improves their ability to target prospective customers more easily, which drives sales growth.

Summary

While this type of strategy requires a lot of capital, it is a great way to generate an income from stocks you want to own.

If you end up being assigned, you can start selling covered calls against the stock position.

You can do this on other stocks as well, but remember to start small until you understand a bit more about how this all works.

Mitigating Risk

With any option trade, it’s important to have a plan in place on how you will manage the trade if it moves against you.

Some traders like to add a deep out-of-the-money long put to reduce risk. For example, a November 20 put option with a strike price of $120 could be purchased for around $70. Buying this put, would cap losses below $120 and reduce total capital at risk.

Please remember that options are risky, and investors can lose 100% of their investment. 

This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.