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SodaStream (NASDAQ: SODA) has been on a wild ride since its 2010 IPO, as momentum investors fell in and out of love with the home beverage carbonation system maker.
SODA is currently more than 50% off its yearly highs and hitting new 52-week lows. Yet, a bullish divergence -- with new price lows but no new highs in volatility -- could signal a bottom is forming. The stock is currently above important four-year support at $30.
I think the reward-to-risk favors the bulls at these depressed levels. This former high-flyer has been trading largely between $35 and $45 since January, so the first target is a move back to the top of the channel. If $45 is exceeded, we can target $55 on a breakout rally.
The $45 target is about 37% higher than recent prices, but traders who use a capital-preserving, stock substitution strategy could more than double their money on a move to that level.
One major advantage of using a long call option rather than buying a stock outright is putting up much less capital to control 100 shares -- that's the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.
You want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:
Rule One: Choose a call option with a delta of 70 or above.
An option's strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)
It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they're worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.
The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option's delta using an options calculator, such as the one offered by the CBOE.
With SODA trading near $32.75 at the time of this writing, an in-the-money $25 strike call option currently has about $7.75 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option has a delta of about 87.
Rule Two: Buy more time until expiration than you may need -- at least three to six months -- for the trade to develop.
Time is an investor's greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.
With these rules in mind, I recommend the SODA Oct 25 Calls at $9.25 or less.
A close below $30 in SODA on a weekly basis or the loss of half of the option's premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $925 or less paid per option contract. The upside, on the other hand, is unlimited. And the October options give the bull trend three and a half months to develop.
This trade breaks even at $34.25 ($25 strike plus $9.25 options premium). That is about $1.50 above SODA's recent price. If shares hit the $45 target, then the call option would have $20 of intrinsic value and deliver a gain of more than 100%.
Recommended Trade Setup:
-- Buy SODA Oct 25 Calls at $9.25 or less
-- Set stop-loss at $4.62
-- Set initial price target at $20 for a potential 116% gain in 3.5 months
Note: If you're getting less than 18% annual returns, your retirement could be in trouble. A new report shows that unless you make that much, you're probably not going to have a comfortable retirement. With another call option strategy, you could generate as much as $3,410 in income each month. Get the details here.
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