Bullish Option Play on Goldman Sachs

03/06/2012 7:00 am EST

Focus: OPTIONS

John Kmiecik, contributor to Investorplace.com, outlines a bullish long call trade on Goldman Sachs (GS).

So far in 2012, many stocks have reached new 52-week highs. However, quite a few equities still `are well below reaching that goal. In fact, some of these names still look like real bargains. Here is one trade idea for Goldman Sachs (GS) that might take advantage of the shares targeting new highs (even if the overall market seems frothy).

The following strategy is for more aggressive bulls and has potentially unlimited upside if the stock rallies.

The Trade: Buy the April 125 GS calls for $3.40 or less.

The Strategy: The long call trade can profit if the stock rises, lifting the call premium as well. This out-of-the-money call’s Delta is currently at 38%, meaning the call value will increase 38 cents for every $1 advance in the underlying shares (all other factors being equal).

See related: Demystifying Delta in Option Trading

Maximum profit is unlimited through expiration as long as GS continues to rise. The maximum loss is capped at 100% of the $3.40 premium paid (plus commissions). Maximum loss occurs if GS is trading below the 125 strike when the options expire on April 20.

Breakeven is at $128.40 at expiration (the strike price plus the premium paid). If GS is trading above this level in six weeks, the long call trade will be profitable.    

The Rationale: For the last six months at least, it seems that GS has been a relative bargain compared to the levels it was trading at just a year ago. The company has a nice cash flow from operations and expanding profit margins. Many analysts rate the stock as either a buy or hold.

Technically, the stock has been moving up since the beginning of 2012, gaining almost 33% year-to-date. The stock spent most of February, however, stuck below resistance around $118. On Thursday of last week (March 1), the stock finally broke through resistance on increasing volume and closed the week just shy of $120.

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It could be considered a bullish sign from a technical perspective if the stock can hold the top one-third of its recent breakout bar. Look for an entry opportunity above $121.24, which was the breakout bar’s high.

By John Kmiecik, contributor, Investorplace.com

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