This Kimberly-Clark (KMB) Trade Could Deliver a Potential 117% Return in 8 Months

Though the overall market remains bullish, with major indices making new all-time highs this week, it never hurts to position yourself in a few defensive names.

We are seeing an unwinding in high-flying speculative stocks and a shift toward boring large-cap stocks that pay dividends and offer the consistency of proven earnings.

Consumer staples have been one of the beneficiaries of this trend, with the Consumer Staples Select Sector SPDR (NYSE: XLP) up 9% since the beginning of February.

[ad#Google Adsense 336×280-IA]I like Kimberly-Clark (NYSE: KMB) as a way to play this sector rotation.

The company manufactures and markets personal care, consumer tissue and health care products, and demand for these items should hold up regardless of economic conditions.

And the 3% dividend yield should help support the stock’s price.

KMB has traded in a range from $102 to $114 since October.

Shares have been consolidating around the $110 level, but an upside breakout of this range targets a move to $126.

Only a close below the $102 support level on a weekly basis would negate the bullish trend.

The $126 target is about 14% higher than recent prices, but traders who use a capital-preserving, stock substitution strategy could make 117% returns on a move to that level.

One major advantage of using a long call option rather than buying a stock outright is putting up much less capital to control 100 shares — that’s the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.

You want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:

Rule One: Choose a call option with a delta of 70 or above.

An option’s strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)

It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they’re worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.

The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option’s delta using an options calculator, such as the one offered by the CBOE.

With KMB trading near $111 at the time of this writing, an in-the-money $100 strike call option currently has about $11 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option has a delta of about 79.

Rule Two: Buy more time until expiration than you may need — at least three to six months — for the trade to develop.

Time is an investor’s greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.

With these rules in mind, I would recommend the KMB Jan 100 Calls at $12 or less.

A close below $102 in KMB on a weekly basis or the loss of half of the option’s premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $1,200 or less paid per option contract. The upside, on the other hand, is unlimited. And the January options give the bull trend eight months to develop.

This trade breaks even at $112 ($100 strike plus $12 options premium). That is only about $1 above KMB’s recent price. If shares hit the $126 target, then the call option would have $26 of intrinsic value and deliver a gain of more than 100%.

Recommended Trade Setup:

— Buy Kimberly-Clark (NYSE: KMB) Jan 100 Calls at $12 or less
— Set stop-loss at $6
— Set initial price target at $26 for a potential 117% gain in eight months

Alan Knuckman

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Source: ProfitableTrading