Yesterday, one of our newest premium members, Frederik, sent me an e-mail regarding a small option debit trade with Johnson & Johnson. He suggested to sell the $95 call expiring in January 2021 and simultaneously buying the January 2022 $95 call. The actual cost of the trade was $25 for 1 contract. Given the nature of the trade setup, and the small debit and short delta associated with it, we get the following picture (based on 20% implied volatility on January 15, 2021):
In order for Frederik to benefit from this trade, the stock would have to drop significantly, with the highest possible return at $95. Also, given the small investment, there might be some attraction to boost the number of contracts. In essence, this type of trades does not pay off unless you can predict the J&J stock price within the next months.
Suggested Trade With Johnson & Johnson
I, therefore, recommend utilizing the following strategy in case you want to do something with JNJ or don't expect any additional profits to be made over the next one year.
We have the following input:
* Buying 100 shares at $153.00
* Dividend Capture of $4.04 per share over the next 11 months
* Dividends do not materially impact the option pricing
* Selling an at-the-money covered call with $150 strike price, expiring in March 2021
* Adding this setup to the equation (net investment of $450). This component itself can be used as a separate trade, as Frederik suggested. Within the $115-$175 range the trade would be profitable, with a maximum profit of $2,600 if JNJ stands at $140 on March 19, 2021
* The comparative investment basis I utilize stands at $15,300 for the 100 shares or 1 time this trade setup.
Now, let's take a look at the returns on March 19, 2021 with 20% implied volatility. As you can determine from the graph below, if JNJ expires within the $140-$150 range, we are expected to generate a 21%-23% return. Our breakeven point stands at $125, or 17% below current market value including the dividends received.
The advantage chart shows us that moderately bullish, neutral and moderately bearish investors can squeeze a lot of money out of this trade setup. If JNJ shoots through the roof, we would generate a maximum return of 11%.
The maximum P&L approximates $3,603 on a $15,300 comparative investment basis. If JNJ trades above $172 at expiration in March 2021, we would start to underperform a traditional buy and hold strategy.
Frederik's suggestion to set up a long call diagonal in JNJ at the $95 strike price does not pay off in case JNJ stays above the $140 threshold. There are better opportunities for those betting on sideways price action in shares of the pharmaceutical mogul.