Tactical Option Trades For The Cautious Investor

Includes: MCD, V
by: John R. Conway

With the Dow Jones Industrial average and the S&P 500 both trading in a range it can sometimes be frustrating for directional traders with the recent tug-of-war the markets have been in lately. The month of May is getting its usual dose of media criticism of "sell in May and go away?" and for option traders whether or not you believe in the "sell in May and go away" idea, there is always be money to be made in the market.

For option traders, one way of being cautious is using risk defined strategies. Risk defined strategies offer investors the opportunity of either being bullish or bearish, but have some protection in case the trade doesn't go their way. The month of May can sometimes be a rocky road since there are many articles on the web to support a strong case for "sell in May and go away" and if investors believe in the old cliché then limiting an investors downside risk can be beneficial. One risk defined strategy that can be good to use in a variety of market situations are spreads. Even with the mixed bag that the month of May presents to option traders, I believe there will be some bullishness in the month of May and some companies/sectors can weather out the storm better than others. For option traders, using risk defined trades when there is uncertainty in terms of direction in the market can be a good strategy to help minimize risk. In this article here are some vertical call/put spread option trading ideas.

Bullish Idea #1 Buy Visa September 120/125 Vertical call spread

Visa (NYSE:V) is a name that I have been bullish on for a while and on March 28, 2012 I wrote an article titled, "Worried About High Gas Prices? Visa Will Profit Either Way" and while high gas prices can be profitable for Visa, Visa is also a play on many other sectors and economic themes. If investors followed this trade recommendation and bought at the close of March 28, 2012 at $119.35 investors had two chances to close out the trade of a profit on April 13th and April 27, 2012 when Visa was around the $123 level.

On May 2, 2012 Visa reported an earnings surprise when Visa reported $1.60 earnings versus consensus estimates of $1.51 When looking back at Visa Q3 earnings, since 2009 the company has reported a positive earnings surprise in every Q3. Visa's earnings were bullish going forward and Visa upgraded/reaffirmed 2013 guidance. Visa is a good example of a company this is continually able to grow through their earnings. FY 2012 guidance is looking at $6.06 with FY 2012 at $7.09 and FY 2014 at $8.18 Being that Visa is a global play investors might be worried about Europe and emerging markets, but when taking a look at Visa's 8-K growth, Visa outside the United States is still growing. When taking a look outside the United States Visa's CEMEA region is comprised of countries in Central Europe, the Middle East and Africa. In payment transactions the United States is still the leader at 38.860, but for cash volume (billions) CEMEA is the leader.

Overall Visa continues to grow through earnings, a solid Warren Buffet pick and a play on many consumer sectors that use Visa to process there payment transactions. Despite the shaky markets Visa has been hanging in there and when looking at the chart below, investors will notice the $116 level as support. When Visa delivered earnings the company was up in after hours, but then dropped when they revealed the Department Of Justice is doing an inquiry on Visas pricing structure. This isn't the first time Visa has had inquires in the past and the $116 level held through the selloff. The stock has slowly rallied despite some down days in the Dow Jones and the S&P 500.

Chart forVisa, Inc.

The last time I recommended Visa the May 120/125 vertical call spread was going for $2.12 and the only thing I am doing differently is going farther out in time. See below for a breakdown of the trade.

Buy (1) September 120 call = 6.40

Sell (1) September 125 call = 4.40

Cost per 1:1 ratio = $200

Breakeven = $122

Max Profit = $300

Days Till Expiration = 137

Bearish Idea #2 Buy June 92.50/90 Vertical put spread

Ever since McDonald's (NYSE:MCD) rose to the $100 dollar barrier the stock has struggled to break this psychological barrier. In the long term it's hard for me to have a bearish stance on McDonald's, since McDonald's can be seen as a defensive play. Since I last wrote about McDonald's on February 14, 2012 McDonald's has been down $6.28 or 6.3% and for a previous look back at the trade please click here. If investors are still worried about global economic worries the slide downward could continue for McDonald's. In the short term McDonald's global comparable store sales rose 3.3% in April, but fell short of the 5.2% expected from analysts. With McDonald's relative strength index getting close to going under 30, McDonald's could be poised for a small pop higher. When technically looking at McDonald's when the stock dips below the lower bollinger band this usually sets up for a short term bullish play, but this has been short lived. McDonald's is also currently under its 50 and 100 day moving averages, which confirms the bearish trend McDonald's has been on.

Chart forMcDonald

For investors that believe there is some more room to the downside here is a bearish play for the hamburger giant.

Buy (1) 92.50 June put = 2.00

Sell (1) 90.00 June put = 1.12

Cost per 1:1 ratio = $88

Breakeven = $91.62

Max Profit = $162

Days Till Expiration = 39

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in V over the next 72 hours.