An Easy Win On A 21st Century Economy Using 19th Century Technology

| September 20, 2017 | 0 Comments

call spreadIf you’re an active investor, you’ve certainly heard the term “crowded trade” before. It’s used to describe a situation where so many investors or traders are on one side of a certain trading strategy, it has become overbought/oversold or there’s no edge left in it.

For example, if every investor thought company XYZ was going to go higher after a new product announcement, the stock would probably already be too high (or fairly priced) before the actual announcement is ever made. In cases like this, the stock will often drop or do nothing after the event takes place because it had already been factored into the price.

You’ll regularly hear the term “crowded trade” when discussing the most popular trades of certain time period. Currently, we are being told Bitcoin, tech stocks, short volatility, and short US dollar are all crowded trades. Does that mean none of these trades can make you money?

As always, the answer varies on the situation. In some cases (Bitcoin is probably a good example currently) the asset in question is/was probably overbought. In other cases, there still may be money to be made (tech stocks may still have some upside). And sometimes, it’s simply a matter of finding the right way to trade a crowded trade thesis.

For instance, buying a NASDAQ ETF may not be the best way to trade tech stocks. Instead, finding individual tech stocks which appear to be undervalued may be far more profitable in the long-run.

Here’s the thing…

According to the talking heads, investing on an improving economy has become a crowded trade lately. Yet, there are so many ways to trade on improving economic fundamentals, I don’t think it’s possible for it to be overdone. Maybe betting on major stock indexes has become overheated, but what about individual sectors?

One somewhat obscure way to bet on an improving economy is by investing in areas like infrastructure and transportation. Specifically, railroads are important to an improving economy as they are perhaps the most efficient method of transporting raw materials within the country.

CSX Corp.One trader is betting big on the upside potential of CSX (NASDAQ: CSX), a nearly $50 billion railroad company.  As you can see from the chart, CSX has had a nice run lately. And, this trader thinks there’s more upside ahead.

The big trade in CSX was a 15,000 lot call spread expiring in November with the stock price at $52.50. The trader bought the 55 calls and sold the 60 calls for a total cost of $1.08. That’s roughly $1.6 million in premium spent. The breakeven for this trade is $56.08, meaning max gain is $3.92 or almost $6 million.

A call spread is used to lower the premium cost of the trade and is especially useful if you think a stock’s upside is capped in a certain time period. Still, it’s clearly a very bullish trade on the stock and a good sign for the economy in general if you believe this trader’s bet is good.

I really like the idea of using railroads to play the economy’s upside. There’s a clear correlation between the two, but many investors don’t pay a lot of attention to the relationship.

If this trade interests you, but you’d prefer to spend less money, you could do a narrower call spread. For example, the November 55-57.50 call spread only costs about $0.70. Breakeven is $55.70, and you can still make $1.80 in profit. Of course, there’s nothing wrong with the 55-60 call spread if you’re willing to spend a little extra in premium for the additional upside.

 

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Category: Options Trading Strategy

About the Author (Author Profile)

Jay Soloff is an options analyst with Investors Alley.

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