Chipotle Mexican Grill is due to report earnings Wednesday after the market close and the options market is pricing in a 7.9% move in either direction. Chipotle stock has stayed above the lower end of the expected range for the last six earnings announcements.
Let's analyze how we can structure an option trade that fits the view that, one, we think Chipotle stock will stay within the expected range and, two, the response to the earnings report is likely to be positive.
Taking the at-the-money put and call for the April 25 expiration, we can see that the expected range is 7.9%. Now that we know the expected range, let's find a bull put spread that has a break-even price roughly 7.9% below the stock price.
Creating A Bull Put Spread
Selling the April 25, 43-strike put and buying the 40.50 put would create a bull put spread. This spread is trading for around 35 cents. Further, that means a trader selling this spread would receive $35 in option premium and would have a maximum risk of $215.
That represents a 16.28% return on risk between now and the end of the week if Chipotle stock remains above 43. If Chipotle stock closes below 40 on the expiration date, the trade loses the full $215.
The break-even point for the bull put spread is 42.65. That is calculated as 43 less the 0.35 option premium per contract. There also is little room for adjustment with short-term trades such as this when held over earnings.
A Risky Trade For Chipotle Stock
A 16% return in a few days would be nice, but the possibility of losing 100% is also very real. As such, this style of trade is only for those with a high-risk tolerance and a bullish outlook for the stock.
According to the IBD Stock Checkup, Chipotle stock is ranked No. 12 in its group. It also has a Composite Rating of 83, an Earnings Per Share Rating of 96 and a Relative Strength Rating of 28.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, and is conservative in his style. He believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ.
