NextEra Energy (NEE) is trying to rebound after falling in practically vertical fashion for seven days starting on Sept. 26. So, let’s examine a trade in NextEra Energy stock called the long diagonal calendar spread, also known as a calendar wheel.
After years of underinvestment within the traditional energy markets, money continues to move into these sectors. The clear tone of the market, however, is risk-off.
So for our investments to pay off, we must look to the longer game and position for future upward motion. We can also take advantage of time and the option premiums collected.
A Trading Idea In The Electric Utility Space
My stance remains, as it has been since early summertime, that market flow continues in a more neutral to negative direction. Markets are in a repricing mode. That will mean price action will grind lower to acceptable values.
Sticking with energy, I move a little far afield with the utility megacap stock NextEra Energy. Though its IBD Composite Rating, at 63 on a scale of 1 to 99, is far weaker than leading growth companies, the electric power provider continues to surprise with its quarterly results.
In fact, after Tuesday’s earnings report, we see that short sellers were caught flat-footed and in the wrong direction. These traders are now in the process of covering their short positions.
The result of such short covering action? At some point the chart of NextEra stock will level out at potentially a higher low and the stock price will hold. This gives us a jagged area to engage. Enter the calendar spread!
The monthly chart will be the most important one to look at. It will be our lead for several months.
The IBD Stock Checkup for NextEra Energy appears to show analysts continually underestimate the ability for the company to perform. Plus, in the option chains I see much more interest in calls than in times past. This situation also helps with option liquidity and our strategy of the calendar wheel.
NextEra Energy Stock: How To Spin The Long Wheel
Under the signals that the stock market might continue to take a breather and stocks might grind in a lower range before breaking back north, the use of the calendar spread with a longer duration is suggested today.
Within the option toolbox, the long diagonal calendar spread serves as a neutral to bullish position. This strategy forecasts near-term prices are within a range but will rise over the longer term.
Here is the long calendar spread with a twist for NEE:
Sell to open 1 NEE Nov. 17-expiration call option with a 58 strike
Buy to open 1 NEE March 15, 2024-expiration 60 call
Total debit of $1.75 for this trade in NextEra Energy stock translates into a break-even cost at 61.75. That is, take the price of the long option strike and add the strike of the long call option.
Notice the strikes are different in this trade. Thus, it will appear as a diagonal in some of our platforms.
You Say Calendar Trade, I Say Diagonal
The nomenclature is not important. Because their strikes are separated by time and do not expire at the same time, I will always refer to these as calendar spreads.
What we want to see in the ideal unfolding of time is that as we get to a week before expiration, we will buy the Nov. 17-expiration 58 call back, and then sell the December call while still holding the March 60 call.
This will reduce the break-even point and increase our profit potential over time. The goal with this trade: create a credit that will make the strike in March “free” or for a credit. I write “free” in quotation marks because the deployment of any capital always involves opportunity cost of some kind.
Defending The Trade
Stock-hunting using fundamental and price strength within the IBD methodology is where I firmly plant myself under the backdrop of the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
Buying a diagonal calendar spread surmises that price action will be somewhat sideways to up (in our current configuration) in the short term. But we also anticipate NextEra Energy stock to break out to the upside, as we get closer to the trade’s time expiration.
Options sellers are positioned to win in two ways: 1) the stock does nothing or 2) the stock moves within the ranges. So we use this concept to minimize the risk of the market exposure.
First, let’s identify key chart levels.
The monthly resistance zone sits near 73, and support sits near 50 for congestion. As a tide determines the lift of the boats, expecting a range here is not out of the question as the market drifts into areas of lower valuations.
Consider these scenarios for the NEE long call calendar spread:
NextEra Energy stock grinds lower but does not break the $50 price for more than three days. It thus shows itself as favorable to the traders looking for longer-term growth.
NEE grinds higher but does not break the $73 price for more than three days. This shows traders are not willing to pay more for the stock at the present time.
The stock breaks out of either of these levels for more than three days and breaks our risk thresholds. We exit the trade.
NextEra Energy stock holds within the range of our short strike before each prior month’s expiration until finally, all we hold is the long March 60 calls. In this way. we can sell four months’ worth of options premium. This potentially makes our break-even price point in NEE well below 60 and in the catbird seat for upward growth.
NextEra Stock: Note On The Short Call Strike
We should not to fret too much if the short strike goes into the money early in the cycle. Why? We can always roll to higher prices to protect the future investment of the long March strike.
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully. Finally, be patient and allow price action to move around a range of your stops.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of “The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology.” She holds no positions in the investments she writes about for IBD. You can find her on Twitter and Stocktwits at @AnneMarieTrades
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