This morning, I’m recommending a bearish ratio put debit spread on The Procter & Gamble Company (NYSE:PG).
Yesterday, the market managed to eke its way into positive territory. It did so despite the turbulent trade news that dogged investors at the open. This morning looks like it will continue that positive trend as the big banks kick off earnings.
JPMorgan Chase & Co. (NYSE:JPM) posted strong earnings this morning, while Citigroup, Inc. (NYSE:C) and Wells Fargo & Company (NYSE:WFC) posted mixed results. The results from C were particularly important because they showed the strength of consumer banking.
But before we get too bullish, I want to recommend caution. There are a few things that could push the market down today — like any negative headlines from Federal Reserve Chair Jerome Powell’s talk today — and a bearish trade on PG could help traders protect their portfolios.
Consumer Earnings Coming Out Today
The strength of consumer banking may not translate to strong earnings from consumer stocks. Today, we got an earnings report from Dominoes Pizza, Inc. (NYSE:DPZ), which beat expectations but lowered DPZ’s guidance for the future, and after the close we’ll hear from Levi Strauss & Co. (NYSE:LEVI).
The bank and DPZ reports make me think the consumer might be in a more complicated position than we thought, but if LEVI has strong earnings, it may mean we’re in for another boom in retail and less-defensive consumer stocks.
PG produces household products that people generally need, which is why it’s thought of as a defensive consumer stock. All the volatility in the market has pushed investors into PG, which performs consistently well and offers a strong dividend. The rising share price has pushed it’s dividend yield lower, making it less appealing. It’s a catch-22 situation.
As its own earnings report approaches, I think we could see some profit taking in the stock. Investors may see this as a good time to get into other consumer stocks with more potential for growth or more generous dividend yields.
Slowing Down in the run up to Earnings
PG has rallied over 70% in the last 18 months, and the stock is still in that long-term uptrend. I don’t expect a drastic pullback, however, in the run up to earnings, I wouldn’t be surprised to see some investors take their profits off the table.
Daily Chart of The Procter & Gamble Company (PG) — Chart Source: TradingView
The company got rejected at just above the $125 level, and it turned lower. Despite the market’s turn to the upside yesterday, PG moved to retest support at the $120 level. A drop below $120 could act as a signal to investors to exit ahead of earnings.
Often times, traders want to avoid holding a stock through its earnings report anyway, and there are no guarantees PG will continue to beat expectations. Earnings are likely to be mixed, as evidenced by the banking reports today. If PG does move lower, I’d like to be ready with a cheap downside trade.
Using a spread order, buy to open 1 PG Nov. 15th $115 put and sell to open 2 PG Nov. 15th $110 puts for a net debit of about $0.15.
Note: Be sure you are opening the monthly PG options that expire on Friday, Nov. 15, 2019.
About Ratio Put Debit Spreads
A ratio debit spread is simply a way to lower the cost of buying options, as the two option(s) that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this ratio put debit spread is a way to lower the cost of establishing a bearish put option trade. Many brokers will require the use of margin and/or a set amount of reserved capital and/or a margin account to execute a debit spread; contact your broker directly for specific requirements.
Because you are short a naked put in this ratio put debit spread, the risk is that you could be obligated to buy 100 shares of PG at the $110 strike price for every 1 contract that you are short of the PG Nov. 15th $110 puts. So, this is inherently a higher risk play.
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