As discussed in our weekly issue last week, and on our weekly call, I will be taking a position in Caterpillar (CAT) today.
Caterpillar is due to announce before the opening bell on August 2.
Iron Condor Earnings Trade in Caterpillar (CAT)
CAT is currently trading for 196.20. Let’s examine an iron condor trade with a high probability of success.
First, let’s take a look at the expected move in CAT for the expiration cycle that I’m interested in. Since CAT is due to report early in the week, I want to go with the near-term expiration cycle.
The expected move or expected range over the next four days can be seen in the pale, orange-colored bar below. The expected move is from roughly 187.5 to 205, for a range of 17.5 points.
Knowing the expected range, I want to place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of 187.5 to 205.
This is my preference most of the time when using iron condors.
If we look at the call side of CAT for the August 5, 2022, expiration, we can see that the 212.5 call strike offers an 87.45% probability of success. So, I’m going to sell the short call at the 212.5 call strike and define my risk with the 217.5 call strike. By choosing the 217.5 call strike to define my risk, I know that there is less than an 8% chance that I will take a max loss on the trade.
Now let us move to the put side. Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 187.5. The 182.5 put strike, with an 84.20% probability of success, works. I’m going to define my risk by choosing the 177.5 put strike with a 90.74% probability of success. This means we have less than a 9% chance of taking a max loss on the downside
We can create a trade with a nice probability of success if CAT stays between our 30-point range, or between the 212.5 call strike and the 182.5 put strike. Our probability of success on the trade is 87.45% on the upside and 84.20% on the downside.
Here is the trade:
Simultaneously:
Sell to open CAT August 5, 2022, 212.5 calls
Buy to open CAT August 5, 2022, 217.5 calls
Sell to open CAT August 5, 2022, 182.5 puts
Buy to open CAT August 5, 2022, 177.5 puts for roughly $0.85 or $85 per iron condor (prices will fluctuate, please adjust accordingly if you wish to enter the trade)
Our potential return on the trade: 20.5%
Our margin requirement is $415 per iron condor.
Again, the goal of selling the CAT iron condor is to have the underlying stock stay below the 212.5 call strike and above the 182.5 put strike immediately after CAT earnings are announced.
Here are the parameters for this trade:
- The Probability of Success – 87.45% (call side) and 84.20% (put side)
- The maximum return on the trade is the credit of $0.85, or $85 per iron condor
- Breakeven level: 213.35 – 181.65
- The maximum loss on the trade is $415 per iron condor. Remember, we always adjust if necessary, and always stick to our stop-loss guidelines when we can.
*Also remember, proper position size is the KEY to long-term success when trading earnings. Keep your size within reason and allow the law of large numbers to do the work. Losses will occur, so manage your position size accordingly