Sometimes, a narrative is so obvious and powerful that you shouldn’t bet against it, which may be the case for semiconductor specialist Marvell (MRVL). However, with MRVL stock more than doubling, it’s difficult to stack the deck in your favor with standard methodologies. Still, that brings us to the options market, specifically a strategy called the bull call spread.
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Let’s back up for a moment to discuss the fundamental reason why MRVL stock soared recently. Late last week, semiconductor rival Broadcom (AVGO) joined the $1 trillion group. This performance stemmed from the company posting strong fiscal fourth-quarter figures, with sales jumping 51% on a year-over-year basis to a record $14.06 billion. Further, the tech giant posted adjusted earnings per share of $1.42, beating the consensus view by 3 cents.
Importantly, management provided an optimistic outlook, projecting $60 billion to $90 billion in sales from custom artificial-intelligence chips by 2027. This wide-ranging excitement bodes well for the entire AI ecosystem. Therefore, MRVL stock jumped in sympathy with AVGO. Subsequently, I am bullish on Marvell, but I’d like to focus on a potentially more effective way of exercising this optimism.
Laying the Foundation of the Call Option Strategy
Under a simple buy-and-hold strategy, investors may acquire MRVL stock in the open market. However, the issue with this approach is the lack of leverage – investors don’t get the chance to amplify their potential returns, as they might with other strategies like options trading. Shares are up 397% in the past five years, meaning that the low-hanging fruit may have long been plucked. Therefore, some people often consider call options, particularly far out-the-money (OTM) calls, in the hopes of scoring big payouts in a short period of time.
Such options are “cheap” because of the improbability that they will be profitable. For a call option to break even, the underlying security must reach the strike price plus the premium paid. Logically, far OTM calls feature tiny premiums. On the other hand, it’s unlikely that the option will reach the breakeven threshold, let alone be profitable. So, a smarter approach may be the bull call spread.
In this multi-leg transaction, a trader buys a call and sells a call at a higher strike price (for the same options chain). The credit received from the sold call (or the short call) helps offset some of the debit paid for the long call. Inherently, the upside reward is capped at the short strike. However, the main benefit is that the long call option is discounted. Further, the breakeven threshold is also lowered by the credit received.
Choosing the Right Call Spread for MRVL Stock
With a popular trade like MRVL stock, it’s possible to choose from hundreds of mathematically viable bull call spreads for any given options chain. So, how does one go about selecting the appropriate strike-price combo? Much of this decision-making process comes down to individual risk-reward tolerance. Call spreads with higher payouts tend to feature low positional risk (less cash at risk) but greater probabilistic risk (less likely to be profitable).
Nevertheless, there are some clues to consider. In particular, TipRanks readers can view the platform’s Unusual Options Activity screener. This data interface showcases the options that have attracted the attention of the smart money. In the case of bull call spreads, it’s important to note calls with bearish sentiment. These are the options that professional investors are willing to sell, indicating potential upside price targets.
For example, last Friday, the smart money sold short 208 contracts of $138 MRVL calls expiring Dec. 27, 2024. This transaction suggests — though it’s no guarantee — that the big dogs expect MRVL to rise no higher than $138 by the aforementioned expiration date. Therefore, a speculator could choose to sell the $138 call (or a strike slightly lower) as part of the short leg of a bull call spread.
Calculating the Probability Matrix of Marvell
Another method to determine the ideal bull call spread to consider is to calculate the probability matrix of the target security. In the case of MRVL stock, the equity has a slightly upward bias. Using weekly data from the past five years, just under 51% of sessions (defined as the difference between Monday’s open and Friday’s close) resulted in a positive return.
However, some bull call spreads where the long leg is in the money (ITM) may feature breakeven prices below the current market value. Whatever this figure is needs to be worked into the probability matrix. For example, there are plenty of bull call spreads where the breakeven threshold is 1% below the open market price. Put another way, the definition of profitability shifts from anything above 0% to anything above a 1% loss.
An easier way to think about this is that a bull call spread can be used much like a golf handicap. With MRVL stock, changing the breakeven threshold to 1% below market boosts the probability of success from 51% to over 58%. Even more probabilistically generous bull call spreads are available at the expense of a lower payout.
Wall Street’s Take on Marvell
Turning to Wall Street, MRVL stock has a Strong Buy consensus rating based on 26 Buys, two Holds, and zero Sell ratings. The average MRVL price target is $122.32, implying 1.97% downside potential.
The Takeaway: Call Spreads May Offer a Better Approach for MRVL Stock
Although Marvell benefits from broader excitement in the AI space, it’s also clear that continued upside may be limited. MRVL stock has more than doubled in value this year, meaning that the low-hanging fruit has been plucked. Rather than buying shares in the open market, then, it may be better to consider a bull call spread.
With this multi-leg options strategy, traders use the credit received from the short leg to help offset some of the debit paid for the long leg. One of the benefits of this trade is that it allows speculators to adjust down the breakeven threshold, sometimes below the current market value. By understanding what the smart money may be doing in addition to calculating MRVL’s probability matrix, investors can determine their ideal call spread.
