[Options] Building Strength

Sean McLaughlin
November 23, 2022

After we got past sharing each others' Thanksgiving dinner menus, wine pairings, and recipe swaps, the All Star Charts gang got back to business this morning hunting for trade ideas.

We arrived at today's idea in a roundabout way:

"Discretionary stocks have been the 'least shitty' performers as of late."

"We're seeing relative strength in 'da homies. [Homebuilders]"

"In that sector, Lennar $LEN is showing the best relative strength relative to the others."

...and that is a taste of how the Thanksgiving sausage is made.

So let's dig into some visuals to highlight what we're seeing.

Here's a big-picture chart of Lennar $LEN:

On a longer-term perspective, $LEN is finding support exactly where bullish investors would like it to (at former pre-covid resistance levels).

When we zoom in, what we really like about this opportunity is that we've got a clearly defined and nearby risk management level that allows us to leverage into a trade that could be a big winner if we get it right, yet gets us out quickly if we're wrong:

While options premiums aren't the highest, they still offer us some nice premiums in nearby puts so that we can sell them and use those proceeds to purchase out-of-the-money calls for a leveraged bet on a run to highs.

Here's the Play:

We like a $LEN May 82.50/92.50 Bullish Risk Reversal for a small net credit in the neighborhood of 20 cents. This means we'll be naked short the 82.50 puts and long and equal amount of 92.50 calls. The amount of the credit isn't of utmost importance, but we'd like it to be some kind of credit.

Due to the naked puts, our brokerages will require around $2100 of margin per one-lot we trade:

Since those naked puts leave us exposed to any serious downside move, we'll be extra vigilant in closing this trade down if we see any $LEN close below $83 per share. That is our signal that we're early or wrong. Either way, we want out.

With May options, this gives us plenty of time for a favorable trend to develop.

If $LEN starts pressing higher, we'll look for any opportunity to use proceeds from selling half of our calls to completely close out all of our short puts. For example, if I can sell one call for $10.00 per contract and buy-to-close two puts for $5.00 each ($10 total), then I'll do so. This will leave me with a #FreeRide on my remaining long calls. With my original risk capital out of the trade, there's no way I can lose, yet I can still make theoretically uncapped gains!

This is how we win big.

If you have any questions on this trade, please send them here.

ASO subscribers who missed last week’s live video Jam Session where we review activity in our options portfolio from the past week can catch it here.

~ @chicagosean

P.S. We do trades like this regularly. If you'd like to leverage Best-in-Class technical analysis into smarter directional options trades, try out All Star Options Risk Free! Or give us a call to learn more: 323-421-7991.

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