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Coinbase Option Spread Has a 50% Return Potential in Less Than 2 Months

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The journey for Bitcoin investors back to all-time highs hasn’t been an easy one. But the world’s largest cryptocurrency by market capitalization has been on a tear since bottoming in late 2022. Bitcoin continues to hover near the $70,000-level after eclipsing its former high earlier this year.

Outside of owning crypto outright, several stocks are making waves in conjunction with Bitcoin’s ascent. The launch of spot Bitcoin ETFs is paving the way for this recent leg higher.

Coinbase (COIN - Free Report) , the largest U.S. cryptocurrency exchange, has been a big beneficiary of the latest move. A Zacks Rank #1 (Strong Buy), Coinbase shares surged nearly 300% over the past year as earnings estimates are on the rise.

Earlier in May, the exchange blew away expectations for the first quarter. Earnings of $1.65/share represented a 58.7% surprise over the $1.04/share estimate, while revenues of $1.64 billion marked a 29.6% surprise. Coinbase has delivered a trailing four-quarter average earnings surprise of 364.6%.

Analysts covering COIN are in agreement and have been raising earnings estimates across the board. Looking at 2024 as a whole, EPS estimates have been increased by 357.32% in the past 60 days. The Zacks Consensus Estimate now stands at $7.18/share, translating to a staggering 1,840.5% growth rate relative to last year.

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Image Source: Zacks Investment Research

While there are many ways to take advantage of this bullish move, options provide us with flexibility, enabling us to tailor our strategy to the current market environment.

The benefit of the recent increased market volatility is that option premiums become very rich. If we purchase an option, we will need to pay a higher premium due to high market volatility. But when we are the option seller, we’ll receive high premiums in the form of cash credited to our brokerage account.

Spreads are extremely effective in this type of environment. Call option debit spreads are implemented by purchasing a call option and selling a related call option with a higher strike price. These types of trades are limited risk trades because the short option is ‘covered’ by the option purchase.

When done correctly, trading options provides huge profit opportunities with limited risk making options one of the most versatile investment vehicles.

Option Essentials

Before we analyze today’s trade, let’s review some option fundamentals as a refresher. There is no need to worry about complex mathematical formulas or equations. Over the years I’ve found that the more complicated a strategy is, the less likely it is to work over the long run.

Options are standardized contracts that give the buyer the right – but not the obligation – to buy or sell the underlying stock at a fixed price, which is known as the strike price. A call option gives the buyer the right to buy a particular security, while a put option gives the buyer the right to sell the same. The investor who purchases an option, whether a put or call, is the option buyer, while the investor who sells a put or call is the seller or writer.

These contracts are valid for a specific period of time which ends on expiration day. There are weekly options, monthly options, and even LEAPS options which are longer-term options that have an expiration date of greater than one year.

Options consist of time value and intrinsic value. In-the-money options consist of both components; at-the-money and out-of-the-money options consist only of time value. At options expiration, options lose all time value.

Below we’re going to explore a call option spread strategy.

The Power of Option Spreads

Coinbase currently meets our criteria for initiating a bullish call option spread position. COIN stock is trending well and outperforming the market this year. The company is witnessing positive earnings estimate revisions, which our research has shown to be the most powerful force impacting stock prices.

The table below displays the risk/reward profile for this trade. COIN is trading at $234.76/share at the time of this writing. This trade involves purchasing the July 190-strike call at 52.55 points, and selling the July 210-strike call at 39.25 points for a total cost of 13.30 points. As option contracts represent 100 shares of the underlying security, this would represent a total cost of $1,330 per spread (orange box).

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Image Source: Zacks Investment Research

The top (blue) row in the lower section shows the performance of COIN stock based on different percentage scenarios at expiration. The last (purple) row shows the corresponding percentage return for our debit spread trade. We can see that regardless of whether COIN increases in price, remains flat, or even loses 10% from our entry, our option spread trade will produce a 50.4% return.

These are types of odds I like to have in my favor when trading options.

Advantages of Spread Trading

1) The Option Sale Provides Downside Protection

The sale of a call option results in cash being credited to your brokerage account. This reduces the cost basis of the option purchase and provides downside protection in the event the price of the underlying stock declines.

2) Risk is Reduced

In the COIN trade just presented, the sale of the 210-strike call reduced the risk of the 190-strike purchase from $5,255 to just $1,330 per contract.

3) Allows Us to Maintain Positions During Volatile Markets

The downside protection provided by the call option sale helps us maintain our spread trade during heightened volatility. Naked option purchases may force us to sell early in order to prevent large losses.

4) Spreads Can Be Profitable If Stock Goes Up or Down

Option spreads can be profitable even if the underlying stock decreases or remains flat, providing us with an entirely new dimension of money-making opportunities.

The call option spread strategy is an excellent way to profit during periods of high market volatility. Remember that the call option sold through this strategy profits as the price of the underlying stock declines, providing us with a cushion during market pullbacks.

Option spreads are a safe way to use the leverage inherent in options. Your risk is limited to the price paid for the spread.

Volatile markets don’t have to be scary; instead, they can present a great opportunity to profit!

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