Li Auto (LI) saw a massive bounce off the 50-day moving average Tuesday in a very bullish move.
Li stock looks primed for a test of the 52-week high around 47 per share and is one of the best Chinese stocks to buy now.
According to the IBD Stock Checkup, LI stock is ranked No. 1 in its industry group and has a Composite Rating of 99, an EPS Rating of 81 and a Relative Strength Rating of 98.
Investors who think Li stock will continue to rally and don’t want to risk significant capital can use long call options rather than buy the stock outright. This can be a good way to protect precious capital in these volatile markets.
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 (strike price) up until a certain date (expiration date).
Call Options Provide Leverage
One of the benefits of call options is that they provide leverage. (This can be both a good and a bad thing.)
Assuming an investor wanted to buy 100 shares of Li stock, he or she would have to invest around $4,300 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 investors were to buy one Li Auto 40-strike call option expiring on Dec. 15, they would only need to invest around $680 rather than $4,300.
The break-even price for this call option is equal to the strike price plus the premium paid, which would make the break-even price 46.80.
Most At Risk Is $680
The most the trade can lose is the premium paid of $680, which would occur if Li Auto finished below 40 on Dec. 15.
However, if LI stock shoots higher, the upside is unlimited.
Using options in this way 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.
Savvy traders can further reduce the risk by selling an out-of-the-money call, turning the trade into a bull call spread.
For example, selling the Dec. 15, 50-strike call would reduce the trade cost by around $280 but would also limit the upside above 50.
A stop loss could be set if Li stock drops 8% from the entry point.
Please 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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