2 Trade Blueprints for Home Depot Options

by Tyler Craig | August 19, 2013 12:03 pm

2 Trade Blueprints for Home Depot Options

The iShares U.S. Home Construction ETF (ITB[1]) has traveled quite the circuitous route to nowhere. After eight months of epic rallies and dramatic downturns, the fund surprisingly now sits unchanged year-to-date.

The week before Bernanke’s infamous tapering comments in mid-May, ITB was up 19% for 2013. Since then, those gains have all but dissipated as the Street has struggled to embrace the new regime of rising interest rates.

ITB 1024x792 2 Trade Blueprints for Home Depot Options
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Of course, the notable reversal of fortune has not affected all housing stocks equally. Some, like Home Depot (HD[2]) and Lowe’s (LOW[3]), have weathered the industry’s setback with only mild weakness — HD is 6.4% off its highs while Lowe’s is down 5.2%.

What’s more, both home improvement retailers’ uptrends remain clearly intact. The weekly chart of HD remains above its rising 50-week moving average and currently sits just above a two-year trendline. Bulls will want to see some type of rebound off of this level to keep the optimism alive.

HD 1024x799 2 Trade Blueprints for Home Depot Options
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Impatient traders won’t have to wait long for Home Depot’s resolution of the trendline test, since the company is set to report its quarterly earnings Tuesday morning. We can assess the options market to determine how traders are gauging risk heading into the main event.

As usual, 30-day implied volatility has risen steadily during the past few weeks as traders bid up option prices in anticipation of the earnings gap. Commensurate to past quarterly volatility lifts, IV has risen to the mid-20s. In analyzing the past seven earnings announcement, I couldn’t identify a decisive victor with volatility buyers vs. sellers; it’s more of a mixed bag than anything.

HDvol 2 Trade Blueprints for Home Depot Options
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If you’re inclined to make a directional bet into earnings, I suggest sticking to the ol’ vertical debit spread. The structure of the position mitigates the bulk of the volatility risk, making it a straightforward directional bet.

Here are two Home Depot options plays for your consideration — one bull and one bear:

Bull

Purchase the Sep 75-80 call spread by buying the Sep 75 call and selling the Sep 80 call for $2.05. The max risk is limited to the initial $2.05 paid. The max reward is limited to the distance between strikes minus the net debit, or $2.95.

Bear

Purchase the Sep 77.50-72.50 put spread by buying the Sep 77.5 put and selling the Sep 72.50 put for $2.10. The max risk is limited to the initial $2.10 paid. The max reward is limited to the distance between strikes minus the net debit, or $2.90.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Endnotes:
  1. ITB: http://markets.financialcontent.com/investplace/quote?Symbol=ITB
  2. HD: http://markets.financialcontent.com/investplace/quote?Symbol=HD
  3. LOW: http://markets.financialcontent.com/investplace/quote?Symbol=LOW

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