United Parcel Service (NYSE: UPS) reported earnings Thursday before the open and investors were not happy with the results. The stock sold off on the day by 6.13% after already dropping over 6% from record highs. The move erased almost two months of work as investors fled from the name.
With every loss comes an opportunity and today we will talk about a specific opportunity on UPS. Given the recent 12% drop, we will look at a play where we can be cautious and reduce risk. Also, since this is a $119 stock, we will look to reduce the capital we put up to try for a profit. To do this we will consider an options trade.
In the March, monthly expiration we will look at the $115/110 short put spread. This means we will sell the $115 put and simultaneously buy the $110. Currently this will bring in a credit of around $1. So what is the point of this trade? Well, we have no assumption that the stock will miraculously recover at this point, but after a 12% decline we can at least assume the stock will not push much lower.
The trade listed above will have a probability of being profitable of around 77%. The short option has a 70% probability of staying out of the money. This is a fancy way of saying that there is a 70% chance that the price of UPS will stay above $115 up until expiration. Given that we will collect $1 in credit, our actual break even is $114, which gives us even more of a cushion. This in turn gives us a higher probability of making a profit.
The hope is that UPS stays above $115 for now. With this type of trade we can afford to be a little off in trying to pick the bottom. The stock price is at $119, so we can afford to see another 3.3% decline and still have a profitable trade. Happy trading!