This Merck (MRK) Stock Bullish Diagonal Trade Targets a Price of $130 by June 18

A bullish diagonal spread is an advanced option trade and generally not suitable for beginners, but it can have its place within an option portfolio.

It is a bullish strategy that benefits from time decay and is best placed when volatility is low, such as the current conditions.

The strategy involves buying a longer-dated call and selling a shorter-term out-of-the-money call against it.

The trade is best placed when the trader has a bullish outlook and thinks the stock could get to the short call strike by the first expiration date.

A rise in implied volatility will benefit the trade as it has positive Vega overall.

The big risk with the trade is a sharp move lower early in the trade.

Let’s look at an example using Merck & Company (MRK).

MRK Stock Bullish Diagonal Example

Merck & Company is in the midst of a strong rally and is rated a Strong Buy. 

The Barchart Technical Opinion rating is a 88% Buy with a Weakening short term outlook on maintaining the current direction.

Long term indicators fully support a continuation of the trend.

Let’s look at how we can use options to find a favorable risk to reward trade on the assumption that MRK stock might rally to $130 or above in the next two months.

We will look at a bullish diagonal spread which allows traders to get long MRK without risking too much capital.

A bullish diagonal spread is a trade that involves buying a long-term call option and selling a shorter-term, further out-of-the-money call option.

Structuring the trade at $130 gives the trade around 28 delta, which is roughly equivalent to being long 28 shares of the stock.

Selling the June 18th $130-strike call option will generate around $210 in premium and buying the September 18th, $120-strike call will cost around $945.

That results in a net cost for the trade of $735 per spread, which is the most the trade can lose.

The estimated maximum profit is around $670, but that can vary depending on changes in implied volatility. The maximum profit would occur if MRK closes right at $130 on June 18th.

The trade benefits from time decay as the short-term option will decay at a faster rate than the longer-term option.

The ideal scenario for this MRK trade is for the stock to move towards $130 in the next few weeks.

A bullish diagonal spread is a good way to gain some upside exposure on a stock without risking too much if the move doesn’t eventuate.

The suggested stop loss level is a close below $115.

Here is a visual of what the trade looks like:

Company Details

Merck & Co. boasts more than six blockbuster drugs in its portfolio with PD-L1 inhibitor, Keytruda, approved for several types of cancer.

Keytruda has played an instrumental role in driving Merck's steady revenue growth in the past few years.

Well-known products in Merck's portfolio include Keytruda, Simponi , Januvia and Janumet, Bridion, Isentress, ProQuad, Gardasil, Pneumovax 23, RotaTeq and Belsomra.

Merck made its biggest acquisition of Schering-Plough and sold off its Consumer Care business to Bayer.

Other key acquisitions include Idenix Pharmaceuticals, Cubist Pharmaceuticals, Rigontec, ArQule and Acceleron Pharma.

IMerck spun off products from its Women's Health unit, legacy drugs and biosimilar products into a new publicly traded company called Organon & Co.

MRK rates as a Strong Buy according to 17 analysts with 2 Moderate Buy ratings and 9 Hold ratings.

Implied volatility is at 30.54% compared to a 12-month low of 21.66% and a 12-month high of 42.85%.

Merck is due to report earnings on April 30th. 

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.