The 'RACE' is on With MicroStrategy Bull Call Spreads

By Josh Enomoto

Let’s just be brutally honest — MicroStrategy (NASDAQ:MSTR) has effectively become a cryptocurrency proxy. I don’t think anyone is paying attention to what the company does other than its acquisitive ambitions regarding blockchain assets. That said, have you taken a look at the bitcoin ecosystem lately? There doesn’t seem to be any stopping this freight train.

Of course, when something keeps moving higher with reckless abandon, there’s always the heightened risk of the bubble imploding. You don’t want to be around when the blistering boom cycle turns into a devastating bust. Until then, however, there’s clearly money to be made for the high-risk, high-reward speculator.

Naturally, the most ideal situation for market gamblers focused on cryptocurrencies is to buy the decentralized assets themselves. However, cryptos have their own unique risk profiles, such as hacking threats or even losing your password. By betting on MSTR stock, one can mitigate some of these “administrative” risks of crypto ownership.

Even better, MicroStrategy stock is a very optionable security, presenting a tantalizing (albeit financially risky) opportunity.

Leveraging the Power of the Bull Call Spread

For MSTR stock, investors may want to consider near-expiry bull call spreads. By focusing on options close to expiration, the reduced theta will have dramatically reduced the premium required to pay for the calls. At the same time, because of the high implied volatility (IV), the derivatives are still quite pricey. A call spread can help.

By simultaneously selling and buying MSTR stock calls, you can defray some of the debit paid for your long call with the credit (income) received from the sale of the higher-strike short call. This approach caps your reward to the point represented by the short call strike. However, your losses are also capped, making the trade relatively predictable: you know what you can earn and what you can lose.

Now, here’s where a lot of financial pundits make mistakes. The process of selecting the strike price combo — the lower long call strike and the higher short call strike — often appears haphazard. Instead, it’s important to establish what the market will give us in terms of projected price output.

We can calculate this figure using stochastic analysis. Here’s the quick-and-dirty approach. Simply multiply the below three metrics together to get your projected high-low price modifier:

• Share price (open market price).

• IV of the target options chain.

• Time decay adjustment (take the square root of the calendar days to expiration divided by 365 days).

So, for the options chain expiring Nov. 29, the unit price modifier comes out to $105.18. We add and subtract this figure to the share price ($430.54 as of Tuesday’s close) to get $535.72 and $325.36. Since we’re assuming a bullish profile, we’re obviously focusing on the high-end target.

The ‘RACE’ is on to Find Ideal Spreads

In an article I wrote for Barchart, I mentioned an approach I have termed RACE, which stands for risk-adjusted capital expenditure. Essentially, many traders assume risk to be a singular concept focused on the most that can be lost in an options trade. However, there’s also another type of risk — the chances of actually being profitable or not.

Of course, it’s impossible to run a correlation analysis on three metrics. So, to get around this problem, I devised a formula to account for the multivariate nature of risk. On a relative scale, I wanted to devise a methodology that accounts for both the cash on the table (and subject to total loss) and the likelihood of the trade winning. A lower risk-adjusted capital expenditure, or RACE, is desirable but to a point.

Ultimately, the name of the game is to acquire as much reward as possible while minimizing your RACE. That’s the beauty of this critical RACE theory, if you want to call it that.

Using RACE, it’s my opinion that the 427.50/442.50 call spread for the Nov. 29 options chain is a highly desirable trade. Sure, there is a significant opportunity cost if MSTR stock rockets higher. However, with cryptos already having gained so much, the subsequent pop — in a little more than a week’s time — may be less than anticipated. In this trade, you’re putting $940 at risk for the chance to gain $560, or a 59.57% payout potential.

The gap to breakeven is only 1.48%, adding to the trade’s compelling nature. And MSTR stock would only have to rise by 2.78% to reach maximum profitability. For an extra kick, you may consider the 422.50/440 call spread. Here, the gap to breakeven is only 0.52% and the payout is 69.9%. However, you do have to put $1,030 at risk to gain $720.

Surely, there are bigger payouts to be had or relatively safer spreads to choose from. However, they’re less likely to be successful in the former case or are extremely expensive in the latter. The aforementioned trades — again, based on RACE — should provide an ideal balance between risk and reward.

Disclaimer: The author did not hold a position in any of the securities mentioned above. The information provided in this article is for educational and informational purposes only and should not be construed as investment advice. Always conduct your own research or consult with a licensed financial professional before making any investment decisions. Past performance is not indicative of future results.