Roblox (NYSE:RBLX) stock has been getting increased attention in recent days. Shares of the company, which is behind the gaming app of the same name, made their Wall Street debut on Mar. 10, opening just shy of $65. Roblox is currently hovering at $95.74.
The gaming platform depends on individual developers to create content. Analysts highlight that as a social media and gaming platform, Roblox could see considerable growth in the coming quarters.
Therefore, potential investors might want to include the stock in their growth portfolio. However, buying 100 shares of RBLX stock would cost around $9,560, a considerable investment for many people.
Some investors prefer to put together a "poor person's covered call" on the stock instead. Therefore, today we introduce a diagonal debit spread on RBLX by using LEAPS options. Such a strategy is sometimes used to replicate a covered call position at a considerably lower cost.
Investors who are new to options might want to-revisit our previous articles on LEAPS options (for example, here and here) first, before reading further.
A Diagonal Debit Spread On RBLX Stock
Current Price: $95.74
52-Week Range: $60.50 - $98.95
LEAPS stands for "Long-Term Equity Anticipation Securities.” Readers might also see websites referring to them as LEAP options or LEAPs.
Investors who believe in the long-run growth potential of underlying assets, such as Roblox stock, could consider using LEAPS options, which are long-dated, usually one to two years till expiration.
Investors like LEAPS as they “cost less” than stocks, as they are offered at option contract prices.
A trader first buys a “longer-term” call with a lower strike price. At the same time, the trader sells a “shorter-term” call with a higher strike price, creating a long diagonal spread.
In other words, the call options for the underlying stock have different strikes and different expiration dates. The trader goes long one option and shorts the other to make a diagonal spread.
In this LEAPS covered call strategy, both the profit potential and risk are limited. The trader establishes the position for a net debit (or cost). The net debit represents the maximum loss.
Most traders entering such a strategy would be mildly bullish on the underlying security—here, Roblox.
Instead of buying 100 shares of Roblox, the trader would buy a deep-in-the-money LEAPS call option, where that LEAPS call acts as a “surrogate” for owning the Roblox stock.
As we write on Tuesday afternoon, Roblox stock is $95.60. Therefore, for this post, we'll use this price.
For the first leg of this strategy, the trader might buy a deep in-the-money (ITM) LEAPS call, such as the RBLX Jan. 20, 2023, 65-strike call option. This option is currently offered at $44.90 (mid-point of the current bid and ask spread). In other words, it would cost the trader $4,490 instead of $9,560 to own this call option that expires in over one and a half years.
The delta of this option is about 0.80. Delta shows the amount an option’s price is expected to move based on a $1 change in the underlying security.
In this example, if Roblox stock goes up $1, to $96.60, the current option price of $44.90 would be expected to increase by approximately 80 cents, based on a delta of 0.80. However, the actual change might be slightly more or less depending on several other factors that are beyond the scope of this article.
So an option’s delta increases as one goes deeper into the money. Traders would use deep ITM LEAPS strikes because as delta approaches 1, a LEAPS option's price moves begin to mirror that of the underlying stock. In simple terms, a delta of 0.80 would be like owning 80 shares of RBLX in this example (as opposed to 100 in a regular covered call).
For the second leg of this strategy, the trader sells an out-of-the-money (OTM) short-term call, like the RBLX Aug. 20, 2021, 100-strike call option. This option’s current premium is $12.83. In other words, the option seller would receive $1,283, excluding trading commissions.
There are two expiration dates in the strategy, making it quite difficult to give an exact formula for a break-even point in this trade.
Different brokers or online websites might offer “profit and loss calculators” for such a trade setup. Calculating the value of back-month (i.e., LEAPS call) when the front-month (i.e., the shorter-dated) call option expires requires a pricing model to get a “guesstimate” for a break-even point.
Maximum Profit Potential
The maximum potential is realized if the stock price is equal to the strike price of the short call on the expiration date of the short call.
In other words, the trader wants the RBLX stock price to remain as close to the strike price of the short option (i.e., $100 here) as possible at expiration (on Aug. 20, 2021), without going above it.
In our example, the maximum return, in theory, would be about $1,553 at a price of $100.00 at expiry, excluding trading commissions and costs. (We arrived at this value using a profit and loss calculator online).
Without the use of such a calculator, we could also arrive at an approximate dollar value. Let’s take a look:
The option seller (i.e., the trader) received $1,283 for the sold option.
Meanwhile, the underlying RBLX stock increased from $95.60 to $100. This is a difference of $4.40 per share of RBLX, or $440 for 100 shares.
Because the delta of the long LEAPS option is taken as 0.8, the value of the long option will in theory increase by $440X 0.8 = $352 (However, in practice, it might be more or less than this value.)
The total of $1,283 and $352 comes to $1,635. Although it is not the same as $1,553, we can regard it as a good approximate value.
Understandably, if the strike price of our long option had been different (i.e., not $65.00), its delta would have been different, too. Then we need to use that delta value to arrive at the approximate final profit or loss value.
Therefore, by not investing $9,560 initially in 100 shares of RBLX, the trader’s potential return is leveraged.
Put another way, the premium the trader initially receives for selling the shorter-dated call option (i.e., $1,283) represents a higher percentage of the initial investment of $4,490 than if the trader bought 100 shares of RBLX outright at $9,560.
Ideally, the trader hopes the short call will expire out-of-the money (worthless). Then, the trader can sell one call after the other, until the long LEAPS call expires in about a year and half.
Position Management
Active position management in a diagonal debit spread is typically more difficult for novice traders.
If RBLX is above $100 on Aug. 20, the position will make less than the potential maximum return as the short-dated option will start losing money.
Then, the trader might feel the need to close the trade early if the RBLX price shoots up and the short call gets caught deep ITM. In that case, the trader might need to close the entire trade and start over, or put together alternative option strategies.
In a regular covered call, the trader might not necessarily mind being assigned the short option as s/he owns 100 shares of RBLX as well. However, in a poor person’s covered call, the trader would not necessarily want to be assigned the short call as s/he does not actually own those RBLX shares yet.
On Aug. 20, this LEAPS covered call trade would, in theory, also start losing money if the RBLX stock price falls to about $81 or below. However, the actual break-even point could be different as there are different variables that affect the price of an option. Understandably, a stock's price could drop to $0, decreasing the value of the long call with it.
Finally, we must also remind readers that deep ITM LEAPS options tend to have high bid/ask spreads. Therefore, every time the trader buys or sells a LEAPS option, there could be a significant transaction cost.
In future weeks, we’ll continue our discussion with different examples of options strategies.