Home Depot is currently holding bullishly above the 21-day exponential moving average, in addition to the 50- and 200-day moving averages. The Dow Jones Industrial Average component is set to report earnings on Tuesday before the market open. So, traders who think HD stock will not move too much following the earnings report could look at an iron condor trade.
Home Depot has stayed within the expected range following four of the last six earnings announcements. And from an IBD point of view, HD stock is attempting to break out of a large cup with handle that hosts a 334.97 proper buy point.
Let's look at an example of how we might set up an iron condor over earnings.
As a reminder, an iron condor is a combination of a bull put spread and a bear call spread.
The idea with the trade? Profit from time decay while expecting that HD stock will not move too much in either direction.
HD Stock: The Iron Condor setup
First, we take the bull put spread. Using the Aug. 18 expiry, we could sell the 315-strike put option and buy the 310 put. Based on recent trading, that spread could have been sold for around $0.50 per share in a set of contracts. The 315 strike roughly coincides with the 50-day moving average in HD stock.
Then the bear call spread. To place this trade, a trader could first sell the 350 call, then buy the 355 call. This spread recently could have been sold for around $0.40 per share.
In total, the iron condor will generate around $0.90 per contract, or $90 of premium per set of options.
The profit zone ranges between 314.10 and 350.90. This can be calculated by taking the short strikes and adding or subtracting the premium received.
Risk Vs. Reward
As both spreads are 5 points wide, the maximum risk for the trade in HD stock stands at (5 — 0.90) x 100 = $410. Therefore, if we take the premium ($90) divided by the maximum risk ($410), this iron condor trade has the potential to return 21.95%.
If price action stabilizes, then iron condors will work well. However, if HD stock makes a bigger than expected move in either direction, the trade will suffer losses.
Trades held over earnings allow little room for adjusting, so they can be a bit hit-or-miss. HD has stayed within the expected range following all six of the most recent earnings releases. Although as we know, past performance doesn't guarantee future performance.
According to IBD Stock Checkup, HD stock is ranked No. 2 in its group and has a Composite Rating of 80, an EPS Rating of 83 and a Relative Strength Rating of 77.
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, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ.
