Software giant Oracle (ORCL) naturally stole the spotlight after releasing its earnings results for its fiscal second quarter. It was a disappointing outing , with earnings per share of $1.47 missing the consensus target by a penny. Also, revenue of $14.06 billion fell short of the $14.10 billion that experts anticipated.
Pick the best stocks and maximize your portfolio:
Given the lackluster performance, there may be a natural tendency to consider shorting ORCL stock with the purchase of put options. With the broader tech sector having enjoyed robust returns, a cooldown materializing wouldn’t be out of the question. Nevertheless, as an options trader, it’s important to consider where the market may head, not where it is right now. Notably, the evidence doesn’t point to a sustained fallout.
Plus, the beautiful thing about the derivatives arena is that one can easily leverage accessible empirical data to improve the odds of trading success. It’s just that relatively few people want to do the legwork. However, those that do can gain a serious advantage. Below, I’ll detail how to make the most out of a bullish position in ORCL stock.
Don’t Fight the Tape in ORCL Stock
The first order of business is to not fight the tape in ORCL stock. Initially, a temptation may exist to get cute with Oracle or its peers, especially after this last weak earnings report. However, the U.S. market has an upward bias, and that certainly applies to established giants like ORCL . In fact, historical data over the past five years indicates that its weekly performance (Friday’s close versus Monday’s open) leans 56% bullishly and 44% bearishly.
In other words, if you were to bet on ORCL stock at the beginning of the week, there’s a 56% chance that your position will be somewhat profitable (not inclusive of administrative fees tied to the transaction). Therefore, unless you had a truly compelling reason to be short Oracle, the empirical data suggests that you should avoid that impulse.
To be fair, a 56% success ratio is solid but not overwhelmingly great. Over the long run — assuming the incorporation of trading discipline and stop losses — you should mathematically win out. However, a 44% failure rate also means that a streak of bad luck can potentially wipe out your position if you’re not careful. This is where a smart options approach can be critical.
Understanding the Advantages of the Bull Call Spread
With a triple-digit price tag, ORCL stock is “expensive” for many retail traders. Therefore, those who are interested in Oracle tend to buy “cheap” call options; that is, call options that are far out the money (OTM). In fact, the New York Stock Exchange website noted that “retail traders are more likely to buy low-priced options than institutions.” That’s not surprising because of the temptation of the low price.
However, low-priced options are usually costly because they’re unlikely to be profitable. So, for retail traders looking for a discount per se, the Bull Call Spread offers a compelling alternative. Here, you buy a call but also sell a call (at a higher strike price) at the same time. The credit received from the short call partially offsets the debit paid for the long call. This process makes the long call much likelier to be net profitable.
Now, it must be said that by buying a bull call spread, the reward is capped at the short call strike. However, since option spreads make the most sense with near-term time horizons, the capping of reward isn’t as consequential due to the limited time. Plus, another advantage of Bull Calls is that you understand the maximum you can lose (the net debit paid) ahead of time. As well, you can close out a position early to help avoid suffering the maximum loss.
Strategizing the Best Call Spread for Oracle
Let’s get into the fun stuff regarding the Bull Call Spread: how to decipher the best spread (i.e. strike price combo). As mentioned earlier, we know that there’s a 56% chance that on any given week, ORCL stock by Friday close will be priced higher than its Monday open. However, if we shifted the goalpost to define success as being above 0.5% down, suddenly, the success ratio of ORCL jumps to 60.2%.
Even better, if success is defined as being above 1% down, the probability of success for ORCL stock soars to 66.3%. That practically means that you have three doors and two chances to open the one hiding the prize. Over the long run, you are quite likely to be profitable. Therefore, it behooves you to select the Bull Call Spread where the breakeven price is 1% below the current market value of ORCL.
The breakeven price is defined as the lower strike price (the long call strike) plus the net premium paid. Therefore, you will need to look at the options chain of ORCL stock and deduct the ask price of the long call by the bid price of the short call. Take this net premium paid and add it to the long call strike to see if it matches the breakeven price.
Recognizing the Multivariate Nature of Risk
With options strategies — and especially with multi-leg strategies like bull call spreads — traders must be aware of the multivariate nature of risk. It’s easy to focus just on the positional risk or the net debit paid (maximum possible loss). However, there’s also the probabilistic risk to consider, which is the likelihood of the trade being profitable or not.
Cheap options, as the NYSE alluded to, are tempting because the positional risk is small. Unfortunately, the probabilistic risk for these trades often runs extremely high because it’s so unlikely for these options to eventually be in the money. So, when deciding on a bull call spread, it’s important to balance these two metrics to a level at which you’re comfortable exposing yourself.
Finally, traders should play around with the probabilities of ORCL stock. For instance, if we define success as being above 2% down, suddenly, the success ratio absolutely skyrockets to 78.2%. And there are bull call spreads that feature breakeven prices of 2% or lower. Now, it might be difficult to snag the maximum reward (by reaching the short call strike). Nevertheless, the chances of partial profitability are extremely high.
Wall Street’s Take on Oracle
Turning to Wall Street, ORCL stock has a Moderate Buy consensus rating based on 18 Buys, eight Holds, and zero Sell ratings. The average ORCL price target is $187.39, implying 1.61% downside risk.
The Takeaway: Use Options to Boost Your Odds of Success with ORCL Stock
As a major software enterprise, Oracle naturally enjoys an upward bias, irrespective of the occasional poor outing. Unless there is a compelling reason to be contrarian, a bullish posture will probably work out best in the long run. However, options traders can bolster their chance of profitability because they’re essentially in the driver’s seat when it comes to the definition of success.
By shifting the framework of what it means to be profitable, the success ratio of ORCL stock can rise exponentially. With discipline and careful money management, traders can leverage the natural northward tendency of Oracle to their advantage.
Disclosure
