2 Option Ideas for a Breakout Stock

02/29/2012 7:00 am EST

Focus: OPTIONS

Tyler Craig of Investorplace.com gives two option trading ideas for popular momentum stock Whole Foods Market (WFM), one suited for aggressive traders and another for more conservative ones. 

The speed at which morning down gaps reverse higher is yet another glaring sign that the bull is alive and well. For example, the Dow dropped almost 100 points right out of the gate on Monday but finished virtually unchanged on the day.

As a matter of fact, shallow pullbacks in a trending market may be one of the easiest ways to spot a strong trend. As long as this unrelenting bid beneath the market remains present, odds favor bullish plays. Of course, one mustn't select stocks willy-nilly. Identifying low-risk, high-reward opportunities remains the name of the game.

See related: The Highest-Probability Gap Set-ups

One such stock that looks downright healthy is Whole Foods Market (WFM). Since early December, each pullback and breakout has proved fruitful for any bulls along for the ride.

The past few weeks have seen WFM digest its 5% earnings gain from Feb. 9. With the stock's ascending 20-day moving average quickly rising higher to support the shares, WFM may be ready to break out to the upside.

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As is usually the case, option traders have a variety of bullish strategies at their disposal to exploit a continued rise in WFM. From a cost standpoint, options on WFM are relatively cheap. Due in large part to the post-earnings "volatility crush," the stock's 30-day implied volatility is currently sitting at multi-year lows. In fact, the average implied volatility for WFM options (calls and puts) is at 23.3%, down from 36.5% just 30 days ago.

See related: Option Volatility Made Simple

More aggressive traders might consider purchasing call options outright, such as the in-the-money April 80 call trading around $3.90 per contract. If WFM is trading above the breakeven price of $83.90 at expiration, the calls will be profitable.

Gains in a long call position are unlimited if the underlying stock rallies, while losses are limited to the premium paid. The maximum loss on this strategy would occur if WFM is trading south of $80 when the calls expire.

Those looking for a more conservative approach might consider the April 80-85 call vertical spread, currently trading for $2.40. To review, the call vertical spread consists of buying to open the April 80 call (again, for around $3.90) while selling to open the April 85 call for a credit of $1.50.

The risk for this bullish call spread is limited to the initial debit paid to open the spread trade ($2.40) and is also maximized if WFM is trading below $80 at expiration. The reward, should WFM be trading above $85 when the options expire, is capped at the distance between strike prices minus the initial debit paid, or $2.60 ($5.00 minus $2.40). Breakeven for this spread is $82.40, or the long call strike plus the initial premium.

By Tyler Craig of TylersTrading.com

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