High-end retailers have taken a beating as global woes have weighed on consumers, causing many to forgo non-essentials like luxury goods.
Handbag maker Coach (NYSE: COH) peaked at multi-year highs just before the euro concerns reemerged this spring. The overall market has dismissed the crisis, but some stocks like Coach have lagged in performance and present opportunity.
The drop from the 2012 high at close to $80 to the lows at $48 has a halfway recovery resistance target of $64, which is also the top of the sideways channel. That target is nearly 12% higher than current prices, but traders could use a stock substitution strategy to make 50%-plus returns on a move to that level.
One major advantage of using long call options rather than buying shares is putting up much less 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.
Simply put, 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 an option with 70%-plus probability.
Delta is a measurement of how well an option follows the movement in the underlying security. It is important to buy options that pay off from a modest price move in the stock or ETF rather than those that only make money on the infrequent price explosion.
Any trade has a 50/50 chance of success. Buying in-the-money options increases that probability. Delta also approximates the odds that the option will be in the money at expiration. 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.
For example, with Coach trading around $57.20 at the time of this writing, an in-the-money $48 strike call currently has $9.20 in real or intrinsic value. The remainder of any premium is the time value of the option.
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.
I recommend the Coach Feb 48 Calls at $10.70 or less.
A close below $50 in the stock on a weekly basis or the loss of half of the option premium would trigger an exit. If you don't use a stop, the maximum loss is still limited to the $1,070 or less paid per option contract. The upside, on the other hand, is unlimited. And the February option gives the bull trend three-and-a-half months to develop.
This trade breaks even at $58.70 ($48 strike plus $10.70 option premium). That is about $1.50 above Coach's current price. If shares hit the $64 price target, then the option would be worth at least $16 for a 50% gain.
Action to Take --> Buy Coach Feb 48 Calls at $10.70 or less. Set stop-loss at $5.35. Set initial price target at $16 for a potential 50%-plus gain in three-and-a-half months.
This article originally appeared on TradingAuthority.com:
High-End Retailer Could Line Your Pockets With 50% Profits