Longtop Financial: Using Vertical Option Spreads to Capture the Next Move

With the market trading relatively flat on November options expiration Friday, there were several stocks that hit my radar which traded higher on BIG volume. In this post, I will name 11 stocks which traded higher Friday November 20, 2009. I will be checking these stocks frequently to see if there is continued buying pushing the stocks higher. This method is just one of the ways I use to pick stocks to structure particular option trades. The second part of this post requires the knowledge of stock options. To learn more about the option strategies outlined in this post, risks, pricing, calculations, other strategies, and options in general, click here.

The table below shows the company, ticker, per share % increase, and volume increase (% increased compared to 50 day average). For your convenience I have ranked the stocks in order from greatest to least volume % change.

One stock from the list above which has appeared quite a few times on my daily breakout stocks on big volume screen is the software company Longtop Financial Technologies (LFT). This stock has been on an absolute tear lately. Therefore, I will be writing a detailed option strategy about Longtop Financial Technologies (LFT) in this post today. Note that many of the stocks listed above will be good plays and many will be bad plays, I list them all to show possible breakout stocks and write about a few of the ones I am interested in trading.

Click chart to enlarge

Looking at the chart above, we can see this stock moved sideways until recent. We can see there is some serious support around the 30 per share range, and resistance around 35. This stock set a new 52 week high at 35.40 on Wednesday November 18, and on Friday it came within six cents of making a new 52 week high, before it traded off its highs to close the day at 35.07. This stock has some serious momentum behind it and could make for a nice trade, however I need to see it make a new 52 week high on above average volume to really give it my blessing. If this stock fails to make a new 52 week high I believe it could trade lower to support and would look at purchasing Vertical Put Spreads, however if this stock trades higher to a new 52 week high on above average volume I would look to purchase Vertical Call Spreads.

BEARISH SCENARIO

Longtop Financial Technologies Vertical Put Spread Option Trade: As stated I am expecting a slight sell off if this stock fails to make a new 52 week high on above average volume. I would become a buyer of Vertical Put Spreads if the stock traded below 34 a share (minor support level) on above average volume. First I would look to purchase December 35 strike put options on LFT, and then I would choose to lower my cost by selling the December 30 strike put options (support level) against them (1 for 1). Using market data as of close Friday, each vertical put spread would result in a net debit of $145 (paying $145 cash).

Profit & Loss: If Longtop Financial trades down near support levels (assuming this position is opened), and closes on December options expiration at or below 30 a share this strategy will return $355 or 245%. If Longtop Financial trades higher after this position is opened and closes at or above 35 a share at December options expiration, this strategy will lose 100% of the premium paid or $145. The break even point for this option strategy is Longtop financial at 33.55 a share at December options expiration.

BULLISH SCENARIO

Longtop Financial Technologies Vertical Call Spread Option Trade: If however LFT makes a new 52 week high on above average volume, I may be convinced to open vertical call spreads on this stock. Using this strategy, first I would look to purchase December 35 strike call options on LFT, and then I would choose to lower my cost by selling the December 40 strike call options against them (1 for 1). Using market data as of close Friday, each vertical call spread would result in a net debit of $150 (paying $150 cash).

Profit & Loss: If Longtop Financial trades higher (assuming this position is opened), and closes on December options expiration at or above 40 a share this strategy will return $350 or 233%. However if Longtop Financial trades lower after this position is opened and closes at or below 35 a share at December options expiration, this strategy will lose 100% of the premium paid or $150. The break even point for this option strategy is Longtop financial at 36.50 a share at December options expiration.

Both of the strategies outlined above require the underlying stock to move in the indicated direction and should not be considered if you think the stock will move sideways in the near future. However if you feel the stock could move to the higher call strike price or to the lower put strike price in the near future, either strategy could yield a nice gain. To get a better understanding of stock options and different option strategies please check out my Simplified Stock Option Trading E-Books. These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

The reason option volumes have surged in the last five years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

Disclosure: No Positions