The iShares Nasdaq Biotechnology ETF (IBB) broke out to a new high this week after IBB stock struggled for several weeks at the 135 level.
Traders who think the trend higher will continue can obtain a bullish exposure via a long call option.
A call option is a contract between a buyer and seller. The contract gives the buyer the right to purchase a certain stock at a certain price (strike price), up until a certain date (expiration date).
One of the benefits of call options is that they provide leverage (this can be both a good and a bad thing).
Assuming an investor wanted to buy 100 shares of IBB stock, they would have to invest around $13,800 at the current price.
Instead, the investor could gain the same exposure using a fraction of the capital by buying a call option.
One call option gives the investor exposure to 100 shares.
IBB Stock: Call Option Trade
If the investor were to buy one IBB 125 call option expiring in Jan 2021, they would only need to invest $2,030 rather than $13,800. If IBB stock goes to $0, the investor loses only $2,030 while still maintaining a similar exposure to the gains.
The IBB 125 call option gives the investor the right to buy 100 shares of IBB stock at 125 up until the expiration date.
The call option costs around $20.30 per share so the investor would need IBB stock to rise above 145.30 (strike price plus premium paid) in order for the investment to be profitable.
There is always a risk with trading on leverage like this. If IBB stock drops below 125 at expiry, the investor would lose 100% of the investment ($2,030). On the other hand, an investor holding 100 shares would lose around $1,313.
Buying a call option is just one of numerous possible option strategies, but it is a very easy one for investors to get started with.
Advanced traders might consider turning this into a spread by selling a further out-of-the-money call. This reduces the cost of the trade, but also limits the upside potential.
Using A Stop/Loss
For a trade like this, I would consider a stop loss if IBB stock breaks back below the 20-day moving average around 133.
It’s important to 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. Consult your financial advisor before making any investment decisions
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ.
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View more information: https://www.investors.com/research/options/ibb-stock-how-to-trade-biotech-breakout-using-long-call-option/