Ark Innovation ETF (ARKK) has been in the news a lot in the last few years and was yesterday featured as the Barchart Chart of the Day.
While the ETF is currently on a Sell rating, let’s look at some option trades that could benefit from a recover in Cathie Wood’s Ark Innovation ETF.
Bull Call Spread
The first strategy is a bull call spread. A bull call spread is created through buying a call and then selling a further out-of-the-money call.
Selling the further out-of-the-money call reduces the cost of the trade but also limits the upside.
A bull call spread is a risk defined trade, so you always know the worst-case scenario. Bull call spreads are positive delta (bullish) and positive vega (benefit from a rise in implied volatility).
Going out to August expiration, a 50-strike call option was trading around $2.70 on Friday, and the 55 call was around $1.25.
Buying the 50 call and selling the 55 call would create a bull call spread. The trade cost would be $145 (difference in the option prices multiplied by 100), and the maximum potential profit would be $355 (difference in strike prices, multiplied by 100 less the premium paid).
A bull call spread is a risk defined strategy, so if ARKK stock closes below 50 on August 19, the most the trade could lose is the roughly $145 premium paid.
Potential gains are also capped above 55, so no matter how high ARKK stock might go, the most the trade could profit is $355.
In terms of trade management, if the spread dropped from $145 to $70, or if the stock dropped below the 21-day moving, I would consider closing early for a loss.
Let’s take a look at another potential option strategy.
Bullish Calendar Spread
Assuming a trader had a target price for ARKK of 60, they could set up a bullish calendar spread centred at that price.
A calendar spread is a trade that involves selling a short-term option and buying a longer-term option with the same strike price. Bullish calendar spreads are positive delta (bullish) and positive vega (benefit from a rise in implied volatility).
Selling the August 19, 60-strike call option will generate around $50 in premium, and buying the September, 60-strike call will cost around $105.
That results in a net cost for the trade of $55 per spread, which is the most the trade can lose.
The estimated maximum profit is around $325, but that can vary depending on changes in implied volatility.
The idea with the trade is that if ARKK stock trades up to around 60, the calendar spread will increase, resulting in a net profit.
A bullish calendar spread is a good way to gain some upside exposure on a stock without risking too much if the move doesn’t eventuate.
The ideal scenario is a rise up to 60 around August 19 with little change (or a rise) in implied volatility.
The final idea we will look at is a long call option trade.
Long Call Option
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 ARKK stock, they would have to invest around $4,600 at the current price.
Instead, the investor could gain a similar exposure using a fraction of the capital by buying a call option.
One call option gives the investor exposure to 100 shares. Like the previous two example, a long call option is positive delta and positive vega.
If an investor were to buy 1 ARKK 40 call option expiring on December 16, they would only need to invest around $1,145 rather than $4,600.
The breakeven price for this call option is equal to the strike price plus the premium paid, which would make the breakeven price 51.45.
The most the trade can lose is the premium paid of $1,145, which would occur if ARKK finished below 40 on December 16.
However, if ARKK stock shoots higher, the upside is unlimited.
Using options in this way can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
Conclusion
There you have three different bullish trade ideas for ARKK stock, but you can use these strategies on any stock on which you have a bullish outlook.
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.
*Disclaimer: On the date of publication, Steven Baster did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. Data as of after-hours, July 10, 2022.
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