Option Trade of the Day: Home Depot (NYSE: HD)
Stocks moved higher for a fifth straight day yesterday and the S&P closed back above its 50-day moving average after eight days below the trendline from the pullback earlier this month.[hana-code-insert name=’adsense-article’ /]The good news is that the daily oscillators haven’t moved up too much yet and it should be a while before they reach overbought levels again.
The trade idea I have for you today is a little more aggressive than normal.
Home Depot (NYSE: HD) will report earnings on Tuesday (2/20) before the opening bell.
It is rare that I see a trade setup that I like well enough to suggest a trade ahead of earnings, but HD is an exception.
The company’s fundamental indicators are really good – earnings growth of 18% annually over the last three years, an ROE of 149%, profit margin of 13.2%, and we just saw an extreme bearish reading from the sentiment. The SentimenTrader Optix reading hit its lowest level in the last three years a week ago.
HD had been trending higher until the recent spike in volatility and the market pullback. The stock was in a trend channel but broke out of it to the upside in November and pulled back to the upper rail in recent weeks. I have seen this before where a stock breaks out of a channel and then for some reason the upper rail becomes support on a pullback. The recent pullback also brought the oscillators out of overbought territory for the first time in several months.
Buy to open the March18 180 strike calls on HD at $9.00 or better. These options expire on March 16. With the company reporting earnings, I wanted an option that was sufficiently in the money to reduce the risk. The stock closed at $185.27 yesterday and given the asking price we are looking at paying 60% in intrinsic value and 40% in time premium. The stock will need to reach $198 for these options to double, but I don’t think that will be a problem as long as the earnings don’t disappoint. Anything in line with expectations or better should lift the stock and allow it to reach our target.
Because of the earnings announcement next week, this is a riskier trade than usual. If the company misses on its earnings expectations, the stock could drop sharply and this could be a total loss. I would make one suggestion with regard to this trade idea and that is to reduce your allocation because of the risk level. If you normally put $2,000 into a trade idea, cut it in half and put $1,000 into this one. This is only an example and should not be construed as advice on how much to put into the trade. I am just suggesting that you should cut your exposure to this one trade.
— Rick Pendergraft
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