ConAgra - time for a defensive move

When you are not certain about a stock's direction, building a collar with stock options protects your position for almost no cost.
By Michael Thomsett ,

Conagra (CAG) - Get Report  stock continues to rise, even though the company's earnings report, released before the bell Thursday, wasn't that inspiring. On Friday morning, shares were up 1.6% after they closed higher Thursday. If you own shares of this stock, what should you do now? The chart reveals some possibilities.

The relative strength index, which measures momentum and is shown in the bottom pane, is very close to entering overbought territory at 70. This is a bearish signal. Several sessions of higher-than-average trading volume also look somewhat bearish. The rising wedge in price also suggests the stock could move lower.

Even with these bearish signals, the overall indication is not that strong, so what action should you take today if you own shares? ConAgra's stock price has risen to nearly $50 from a January low near $38, so is now a wise time to take profits? Or would you prefer a defensive strategy that costs almost nothing?

We looked at the July 15 options for such a defensive strategy. These options expire in 14 days. One hour into Friday's session, the 49 call option had an ask price of 0.55, and the 48 put option was bid at 0.45.

You can use these two options to set up what's known as a collar. That means you hold your shares of ConAgra stock, you sell an out-of-the-money call option and you buy an out-of-the-money put option. (Remember that each options contract covers 100 shares of the underlying stock!)

If you sell the 49 call and buy the 48 put at Friday morning's prices, you get a net credit of 0.10. Accounting for trading fees of $18, you'll wind up with a net cost of $8 for the trade.

If the stock price rises, the covered call option will be exercised and the stock will called away. As long as you paid less than $49 per share, this is a positive result; however, the stock has not traded that high during the recent past. If the call goes in the money, it can also be closed or rolled forward to avoid exercise. The long put will increase in value if the stock price falls below the option's strike price of $48. 

This collar is advantageous no matter which direction the price moves. It sets up a capital gain if the stock advances, and freezes market risk if the stock price declines. Based on how the situation looks at the moment, this is a wise defensive strategy.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

Besides blogging atTheStreet.com,Michael Thomsett alsoblogs at theSeeking Alphaand several other sites.He has been trading options for 35 years. His website lists his options books: Thomsett Publishing Website- he has also published a paper in the current issue of the Journal of Technical Analysis - link at JOTA issue 69 -- this paper challenges commonly held beliefs about market efficiency and poses a trading system that can beat the market. His new book can be viewed at tinyurl.com/z44kzlu

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