Home Depot popped onto my radar on Tuesday as it failed at the declining 50-day moving average. Home Depot stock also entered SwingTrader on Tuesday as a short sale idea.
The IBD Stock Checkup shows Home Depot stock ranks 13th in its group. It also scores a Composite Rating of 66, an EPS Rating of 88 and a Relative Strength Rating of 57.
This is the sort of setup I'm looking for when scouting for bearish option trades. So, let's look at a bearish diagonal put spread.
Home Depot Stock: Setting Up The Diagonal Put Spread
For Home Depot stock, I'll be looking to buy a November 18-expiration put option with a strike price of 290 for around $23.50. Then I'd sell an Aug. 19-expiration 260 put for around $4.60.
The total cost of the trade is the net premium paid, estimated to be around $18.90 or $1,890 for a standard contract of 100 shares.
The strategy earns the most profit if HD stock closes right at 260 at August expiry; one can estimate the profits at around $1,750 per contract.
If HD drops even further, the trade will still make around $200. If I'm still bearish on Home Depot stock after the August 19 expiration, I can sell another monthly put or simply hold the long put, the cost of which will have been reduced by the premium received for any sold options.
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Risk Vs. Reward
The net delta on the trade is -29 so the exposure is roughly equivalent to being short 29 shares of HD stock, although this will change as the stock moves up or down and the trade progresses.
In terms of risk management, I would set a stop loss of 20% and if the trade is down roughly $380, I would close out this trade in Home Depot stock.
Home Depot is due to report earnings around Aug. 16, so I may close the trade before then.
Adding some bearish trades to your option portfolio can help offset the risk of other bullish trades and neutralize your overall market exposure.
Please remember that options are risky, and investors can lose 100% of their investment.
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
