On Friday we detailed an options trade idea in The Home Depot’s (HD) in front of this mornings earnings report for those long the stock who might consider a stock alternative strategy with defined risk into the potentially volatile event, or for those without an existing position who wanted to play for a breakout. Here was the trade:
Trade Idea: HD ($133.60) Buy May 134 / 138 / 142 Call Butterfly for $1
- Buy 1 May 134 call for 2.50
- Sell 2 May 138 calls at .80 or 1.60 total
- Buy 1 May 142 call for 10 cents
We like these trades when stocks are near their highs because long holder can define risk and those late to the party can make sure they’re not burned too badly on a bad entry near the highs. If the stock goes up the alternative often works similarly to being long stock and if the stock goes down significantly the losses are capped at a fraction of the move. In the case where we detail strikes that are just out of the money the worst case scenario is that the stock doesn’t move much at all or is down slightly. In those scenarios the risk is what was paid for the options can lose more than the stock itself. That scenario is sort of what happened in HD, so let’s check in on the trade.
With the stock at 133.25, down slightly from entry of the post at 133.60 the $1 paid for the call fly is now worth about .75, or a loss of .25. That’s basically in line with the move lower considering the costs of executing the trade. But what now? These options expire on Friday so there’s not a ton of time for those 134 calls to come back into play in any serious way. The stock initially was higher on the earnings news but has now settled in at this level. Therefore it makes sense to close the options and re-buy the stock for those where this is a core long (actually, just closing one 144/148 call spread does the trick vs re-buying the stock as the other 148 call can serve as a buy write until Friday where it will then expire worthless, avoiding commissions)
For those that weren’t long stock the trade can simply be closed for the .25 loss and hopefully it was worth the shot. At this point it is a call on the direction of the stock over the next few days. The out of the money-ness of the 134 calls will become an issue quickly, so it makes sense to make a call sooner than later.