As earnings season is entering its key period, UBS's derivatives department recommended Call Spreads to cope with this earnings season.
Stuart Kaiser, head of derivatives at UBS, said:
options volatility is higher during earnings season, which makes investors need to pay higher costs for big companies options.
But buy call or call spreads on companies such as $Apple(AAPL)$ , Amazon (AMZN)$, Tesla (TSLA)$ and $Meta Platforms, Inc.(META)$ are still attractive because those stocks have fallen so much this year. The only one that has outperformed the $S&P 500(.SPX)$ is $Apple(AAPL)$ , but it is still down 15% year-to-date.
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This article will introduce you Call Spreads and practical options strategy recommended by UBS.
Before we start, let's review the basic definitions of "buy/ sell call".
When investors "Buy Call", it means they are bullish on a stock or other security and believe it will rise to the strike price.
For example, if Mike buys $Apple(AAPL)$'s call at $155 and expires on July 29th, it means that he is bullish on Apple until July 29th, and if Apple is above $155 at the expiration date, he will buy $Apple(AAPL)$ at its striking price.
When investors "Sell Call", they are bearish on this stock and don't think it will rise to the striking price.
For example, if Mike sells Apple's call at $155 that expires on July 29th, it means he Apple will not rise to $155 before expiration and earn the premuim of this contract. But if it rises to $155 at expiration, Mike will passively short the Apple at the strike price.
After reviewing the "Buy/Sell Call", let's look at the Call Spreads:
1. Bull Call Spread
A bull call spread consists of one long call with a lower strike price and one short call with a higher strike price. Both calls have the same underlying stock and the same expiration date.
This strategy is betting on a limited increase in stock prices. The premium earned from "sell call" offsets the premium paid for "buy call" proportionately, and such a combination also reduces margin requirements in practice.
A bull call spread is often used if a trader believes that an underlying will appreciate within a limited space.
Bear Call Spread
A bear call spread consists of one short call with a lower strike price and one long call with a higher strike price. Both calls have the same underlying stock and the same expiration date.
2. 3 Scenarios of Bull Call Spread
The loss and gain of a bull call spread is limited because investors set a high and low strike price respectively. There are 3 possible scenarios.
At expiration, the stock price falls below the lower strike price: the Long Call is not exercised and the premium from the Shrot Call offsets part of the cost. The overall loss is the net difference between the two Call premiums.
At expiration, the stock rises above the lower strike price, but below the higher strike price: the Long Call is exercised and investors buy the underlying stock at the strike price. Mike, in this case, earns both the premium and gains from underlying stock. (If Mike closes the Call before expiration, he will also get benefit from the upward options premium.)
At expiration, the stock rises above the higher strike price: both Long Call and Short Call are exercised, i.e., Mike buys the underlying stock at the lower price and sells it at the higher strike price. The profit is the net difference between the two strike prices.
In summary, for bull call spreads, the loss is limited and gains are limited because the investor can only lose or profit from the net cost of the spread.
3. Options Trading Strategy Recommended By UBS
$ Apple (AAPL) $ will report earnings on July 28, and UBS reported that it might be a good bet to BUY Call that expires on August 5 at $155. It's a one-sided Buy Call strategy that means UBS is bullish on Apple returning to at least $155, and doesn't set ceiling.
At the same time, UBS thinks $Meta Platforms (META)$ has fallen a lot so far this year and that its advertising business could beat earnings estimates in Q2. UBS's recommendation for $Meta Platforms, Inc.(META)$is to trade the Bull Call Spread that expires on Aug. 5, buying $180 Call and selling $200 Call. In contrast, UBS appears less bullish on Meta.
Conclusion
The broader market is showing a sign of making a bottom in the current earnings season. But there is still the Fed meeting in July next week.
Some stocks may have reached the bottom but again don't seem to be going up significantly. If you are bullish on the company at this time, you can use Bull Call Spread.
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