How to Play Stocks Upside Breakout

Market Summary

Stocks finally broke out their months long trading ranges and the major indexes settled at the highest levels in five months. Investors are setting aside worries about European debt problems and focusing more attention on the upcoming earnings season. Traditionally, company earnings announcements will lift the market higher, especially if there are no major earnings disappointments. The SPY chart down below will confirm the price breakout. The SPY is an exchange traded fund (ETF) that seeks to replicate, net of expenses the S&P 500 index. The index is composed of 500 selected stocks, and spans over 24 separate industry groups. It is heavily weighted towards stocks with large market capitalizations and represents approximately two-thirds of the total market value of all domestic common stocks. The fund holds all of the S&P 500 index stocks. It is comprised of undivided ownership interests called SPDRs.

Investor Analysis

As mentioned above, with the beginning of company earnings announcements, stocks upside breakout might have legs. After being stuck in a many months long trading range the market appears primed for an upside move. However, the market is probably still susceptible to global economic headline news and an unexpected negative report could halt stocks advance.

Possible Strategy

Investors can consider a debit spread strategy to benefit from continued higher stock prices - but also provide a layer of protection if the market pulls back. A simple trade is to buy an at-the money (ATM) stock or option and protect against a price drop by simultaneously selling the exact same investment, but out-of-the-money (OTM). For example, buying the February $131 strike price SPY call for $2.00 (yesterday's closing price) and simultaneously selling the February $134 call at .90 would cost $1.10 per share ($2.00 minus .90). But you gain $3.00 per share if the prices continue moving up past the $134 prior to February option expiration ($134 minus $131) – more than doubling your money if the trade works ($3.00 gain minus $1.10 paid = $1.90 per share profit (multiplied by the number of shares represented by the option contracts). The most you could risk is the $1.10 purchase price. Sign up for the http://blog.theoptiontrader.com for additional option trading strategies.

By Gregory Clay