There was a corporate shakeup in the office supply world in February when Office Depot Inc (NYSE:ODP) and OfficeMax Inc (NYSE:OMX) announced their intended merger. Both ODP and OMX rallied on the news, but as the reality of taking on No. 1 Staples, Inc. (NASDAQ:SPLS) set in, share prices retreated back to their February breakout bases.
Staples, Inc. (NASDAQ:SPLS) has traded in a range between $26 and $10 for the past five years. The midpoint target sits at $18 on a recovery to the halfway point of the multi-year price decline.
More recent action has seen a base form just below $11 last fall with a breakout above $14 in May, which is downside support to lean on. The $14 level is also the midpoint of the 52-week high at $17 and low at $11.
The $18 target is about 19% higher than recent prices, but traders who use a capital-preserving, stock substitution strategy could make 22% profits on a move to that level.
One major advantage of using long call options rather than buying a stock outright is putting up much less capital 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 a delta of 70 or above.
An option’s strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)
It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. 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.
The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option’s delta using an options calculator, such as the one offered by the CBOE.
With Staples, Inc. (NASDAQ:SPLS) trading near $14.75 at the time of this writing, an in-the-money $10 strike call option currently has $4.75 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option currently has a delta of about 92.
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.
With these rules in mind, I would recommend the Staples, Inc. (NASDAQ:SPLS) Jan 2015 10 Calls at $5 or less.
A close below $10 in Staples, Inc. (NASDAQ:SPLS) on a weekly basis or the loss of half of the option’s premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $500 or less paid per option contract. The upside, on the other hand, is unlimited. And the January 2015 options give the bull trend a year and four months to develop.