Earnings season is nearing the end.
But, as those who pay close attention understand, earnings season always ends with a bang with Home Depot (HD), Lowe’s (LOW), Target (TGT) and several others due to announce over the next several weeks.
I use the weekly table above as a guide to what I want to focus on in the week ahead. It provides me with some simple but important implied volatility readings along with the average move after earnings, which gives me great insight into how I will approach my strategy of choice (which strikes to use, etc.).
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As I’ve stated in the past, I hope that by going through a few examples of various options strategies every earnings season we can start to build a solid foundation on how to appropriately apply options selling strategies with a focus on high-probability trades.
Today I’m going to focus, once again, on Home Depot (HD).
The retail behemoth is due to announce before the opening bell on February 22. I’m going to go through a risk-defined strategy and an undefined risk strategy taking a high-probability approach. I hope this continues to be a helpful exercise for not only trading around earnings, but for also using similar strategies using various timeframes (expiration cycles).
Here is how Home Depot has performed immediately following earnings dating all the way back to November 12, 2006.
Image courtesy of Slope of Hope
As you can see, Home Depot tends to be quite volatile after earnings. But that’s okay, it’s always good to see what a trade is offering us, particularly one that might seem a bit more aggressive given Home Depot’s recent action around earnings. But if the premium and probabilities make sense, well, we might have a nice opportunity at hand.
Let’s take a closer look.
Iron Condor Earnings Trade in Home Depot (HD)
Home Depot (HD) is due to announce before the open next Tuesday. So, let’s take a look at a potential trade using a risk-defined options strategy like an iron condor.
The stock is currently trading for 348.43.
The next item is to look at Home Depot’s expected move for the expiration cycle that I’m interested in.
The expected move or expected range over the next seven days can be seen in the pale orange colored bar below. The expected move is from 331 to roughly 365, for a range of $34.
Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of 331 to 365.
This is my preference most of the time when using iron condors.
If we look at the call side of HD below for the February 25, 2022, expiration, we can see that the 370 call strike offers an 85.65% probability of success and the 375 strike offers us a 90.03% probability of success. For this example, I’m going to sell the short call at the 370 call strike and define my risk with the 375 call strike. By choosing the 375 call strike to define my risk, I know that there is less than a 10% chance that HD will close above the 375 strike at expiration.
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 331. The 315 put strike, with an 86.36% probability of success, works as our short put strike. I’m going to stick with a 5-wide spread on the put side as well so the 310 will define our probability of success on the downside. The 310 put strike has an 88.70% probability of success. This means there is less than a 12% chance of taking a max loss on the trade.
We can create a trade with a nice probability of success if Home Depot stays between our 55-point range, or between the 370 call strike and the 315 put strike. Our probability of success on the trade is 85.65% on the upside and 86.36% on the downside.
I like those odds. But do I like them enough to take the trade?
Here is the trade:
Simultaneously:
Sell to open HD February 25, 2022, 370 calls
Buy to open HD February 25, 2022, 375 calls
Sell to open HD February 25, 2022, 315 puts
Buy to open HD February 25, 2022, 310 for roughly $0.85 or $85 per iron condor
Our margin requirement is $415 per iron condor.
Return on the trade is 20.5%.
Again, the goal of selling the HD iron condor is to have the underlying stock stay below the 370 call strike and above the 315 put strike immediately after HD earnings are announced.
Here are the parameters for this trade:
- The Probability of Success – 85.65% (call side) and 86.36% (put side)
- The maximum return on the trade is the credit of $0.85, or $85 per iron condor; that’s a 20.5% return per iron condor
- Break-even level: 370.85 – 314.15
- The maximum loss on the trade is $415 per iron condor. We always adjust if necessary, and always stick to our stop-loss guidelines. Position size, as always, is key.
But before I pull the trigger, let’s take a look what our margin of error is on the upside and downside.
With Home Depot currently trading for roughly 348.50, our short 370 call strike is 21.50 points away for a 6.17% margin of error.
On the downside, our short 315 put strike is 33.50 points away, for a 9.6% margin of error.
As for Home Depot’s current IV rank?
Take a quick look at the chart above and you can clearly see we are experiencing some of the best premium in years.
Nonetheless, a trade in Home Depot, particularly with the recent market price action, is not for the faint of heart. But with a pegged IV rank, good premium and an opportunity for a high-probability trade with a nice margin of error Home Depot will be tops on my watchlist heading into next week.
Remember, I prefer to make these trades the day before earnings are announced, so I would expect to see the premium a bit lower than it is now due to decay. So, premium could be an issue at the time of the trade. But I like to see where potential trades stand the week prior, so I have a good understanding what stocks look appealing for a potential trade around earnings, which is why I go through this exercise with the stocks on my weekly earnings watch list.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.