PayPal (PYPL) is currently in a nasty downtrend, falling below a declining 50-day moving average. The stock also put in a bearish candle yesterday, closing near the low of the day. So, let’s look at how to set up a bearish option trade in PayPal stock via a bear call spread.
PayPal Stock: Setting Up A Bear Call Spread
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.
The strategy can score a profit if the stock trades lower, sideways, and even if it trades slightly higher — so long as it stays below the short call at expiry.
On PayPal stock, an options trader could execute an August-expiring bear call spread using the 75 strike as the short monthly call option and the 80 strike as the long call. On Tuesday, that spread traded for around $1.85.
If executed at that price, the maximum profit on the trade would hit $185 per contract with a maximum risk of $315.
The spread will achieve the maximum profit if PYPL closes below 75 on Aug. 19, in which case the entire spread would expire worthless, allowing the trader to keep the $185 option premium.
Risk Vs. Reward
The maximum loss will occur if PayPal stock closes above 80 on Aug. 19, which would see the premium seller lose $315 on the trade.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy, and you always know the worst-case scenario in advance.
You could set a stop loss if PYPL trades above 75, or if the spread value rises from $1.85 to $3.
As this is a bearish position, traders that think PayPal stock could move higher from here should not enter this trade. Traders may also prefer to wait until after the Fed minutes before opening new trades.
Poor Relative Strength
Please remember that options are risky. Investors can lose 100% of their investment.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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