Nio (NIO) stock is looking set for an attempt at the November high of 57.20 after a successful retest of the 50-day moving average.
Nio stock is benefiting from some of the tailwinds from Tesla‘s (TSLA) popularity as electric-vehicle manufacturers continue to outperform.
An Option On Nio Stock With Less Risk
Investors who think they may have missed the rally in Nio stock and don’t want to risk significant amounts of capital can use long call options rather than buying the stock outright.
A call option is a contract between a buyer and seller. The contract gives the buyer the right to purchase a certain stock at a certain price (the strike price), up until a certain date (the expiration date).
One of the benefits of call options is that they provide leverage (this can be both a good and a bad thing).
Assuming investors wanted to buy 100 shares of Nio, they would have to invest around $4,700 at the current price.
Instead, the investor could gain a similar exposure using a fraction of the capital by buying a call option.
One call option gives the investor exposure to 100 shares.
If an investor were to buy one Nio 35 call option expiring in March 2021, he or she would only need to invest around $1,750 rather than $4,700. If Nio stock goes to $0, the investor loses only $1,750. The investor still maintains a similar exposure to the gains.
The Nio 35 call option gives the investor the right to buy 100 Nio shares at 35 up until the expiration date.
The call option costs around $17.50, so the investor would need Nio stock to rise above 52.50 (the strike price plus premium paid) in order to be profitable on the investment.
Risk Of Trading On Leverage
There is always a risk with trading on leverage like this of course, and if Nio drops below 35 at expiration, the investor would lose 100% of the investment, which is the $1,750. An investor holding 100 shares, on the other hand, would lose at least $1,200.
Savvy traders might consider reducing the cost of the long call by also selling an out-of-the-money call. This reduces the cost but also reduces the gain potential.
For example, the April 75 strike call can be sold for around $5.65, which would reduce the cost of the long call by $565, but would cap any gains above 75. The total cost of the spread would be $1,185, which would also be the maximum loss. The maximum potential gain would be $2,815.
Long call options and bull call spreads can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
It’s important to remember that options are risky and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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