Banks as a group have had a great couple of years with super-low interest rates and the essentially zero cost of money. The Financial Select Sector SPDR (NYSE: XLF) has risen almost 200% in the past five years, and monetary policy doesn’t appear to be changing anytime soon.

The yearlong trading range between $18 and $22 targets a $4 move on a breakout and a 20% extension of the rally run.

One stock that is lagging behind the sector and likely to play catch-up is Morgan Stanley (NYSE: MS).

MS has support just below the technical pivot at $28. An upside breakout of the four-month trading range between $28 and $32 targets a move to $36. Only a close below $24 on a weekly basis would negate the bullish trend.

#-ad_banner-#The $36 target is about 18% higher than recent prices, but traders who use a capital-preserving, stock substitution strategy could make almost 70% on a move to that level.

One major advantage of using a long call option rather than buying a stock outright is putting up much less capital to control 100 shares — that’s the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.

You want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:

Rule 1: Choose a call option with a delta of 70 or above.
An option’s strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)  

It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they’re worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.

The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option’s delta using an options calculator, such as the one offered by the Chicago Board of Exchange.  

With MS trading near $30.50 at the time of this writing, an in-the-money $25 strike call option currently has about $5.50 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option currently has a delta of about 81.

Rule 2: Buy more time until expiration than you may need — at least three to six months — for the trade to develop.
Time is an investor’s greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.

With these rules in mind, I would recommend the MS Jan 2015 25 Calls at $6.50 or less.

A close below $24 in MS on a weekly basis or the loss of half of the option’s premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $650 or less paid per option contract. The upside, on the other hand, is unlimited. And the January options give the bull trend almost 11 months to develop.

This trade breaks even at $31.50 ($25 strike plus $6.50 options premium). That is only about $1 away from MS’ recent price. If shares hit the $36 target, then the call option would have $11 of intrinsic value and deliver a gain of almost 70%.

Action to Take –>
— Buy MS Jan 2015 25 Calls at $6.50 or less
— Set stop-loss at $3.25
— Set initial price target at $20 for a potential 69% gain in 11 months

This article was originally published at ProfitableTrading.com:
Bank Laggard’s Catch-Up Rally Could Produce 69% Profits

P.S. By using a similar options strategy, my colleague Amber Hestla is generating payments of $1,047, $2,435, $3,410 (and sometimes more) from nearly any stock — including ones you may already own. This free report explains everything, including names and tickers.