AEO Backratio Call Spread

Another trade I found using prophet chart pattern screener. AEO is American Eagle - another retailer that should have had a good earnings quarter because of back to school shopping. Additionally, yesterday's consumer confidence and retail numbers point to a stronger retail industry. On the other hand there is plenty of speculation about the retail sector being overbought. But, just like the overall market, the bulls are relentless in the sector. Thus, in the very short term, I am bullish on AEO, which leads me into my trade:



As you can see the stock has been trading within the rising channel for about a month. I am entering the position while the stock is at the bottom of the channel. I am concerned that there is a small bear flag within the past week and the earnings report could mean a breakout to the negative for this flag. On the other hand, the past two earnings reports catapulted the stock up significantly.

Overall, I feel the bullish signs outweigh the bearish signs.

The Trade
I bought a back ratio call spread:
Bought 10 Sep09 12.5 Calls for 2.35
Sold 5 Sep09 10 Calls for 4.70

If you do the math, turns out my total cash outlay was a whopping $0 (except commission). That's right, I am able to bet on AEO being bullish without putting out a single dollar. Addtionally, this also buys me some insurance if there is a bear flag breakout. If the stock falls below 12.5, my risk profile reverses and I start losing less. If the stock falls below $10, I break even for the trade. Once again, I am nearly direction neutral.

If the stock rises to around $16, near the top of the channel, I make around $500.

My max loss -at expiration - is $1250. I will not be holding on till expiration and worst case scenario will exit the position if there is a breakout on the bear flag.

I am actually unsure about how to calculate my percent return on this because any money I make (or lose) is technically infinite. My margin requirement is also 0 because I am hedged both ways.

Overall, the best characteristic of this trade is that it is free. Additionally, I am somewhat direction neutral and I particularly like that because there are chances of a breakout in either direction.