We’re getting closer to the end of earnings season, and before Lowe’s Companies, Inc. (NYSE:LOW) reports tomorrow, I think it is worth taking a position.
The S&P 500 fell by 3.5% yesterday amid another COVID-19 related panic. LOW also dropped, but by a comparatively smaller 1.92%.
The company is expected to show significant revenue and earnings growth when it reports, and even with the stock’s pullback yesterday, it remains well above both of its moving averages.
I believe a strong performance this week, especially amid the push out of stocks and into safe-haven assets like bonds and precious metals, could lead to some profit taken after earnings. But I also believe LOW could continue rising after this pullback.
My recommendation is to use a calendar call credit spread to collect income up front and set up a chance to collect more profits later.
Interest Rates, Homebuilders and LOW
Long-term interest rates are low right now, which is particularly good for homebuilder stocks. The lower rates mean mortgage costs are lower, and that means more consumers can buy homes.
Companies like Home Depot, Inc. (NYSE:HD) and LOW provide materials to homebuilders, in addition to consumers, so they are well positioned to benefit from this housing boom.
HD reported earnings, this morning, and though the company beat both earnings and revenue expectations, its revenue for the fourth quarter of 2019 was lower than revenue in the fourth quarter of 2018.
After its premarket rise, we could see some profit taking.
HD’s report could send investors into LOW, which reports tomorrow, and we could see a similar performance from the other home improvement retailer.
LOW Needs Time to Overcome $127
As mentioned above, conditions are perfect for companies like HD and LOW. They get more business as more homes are built.
It’s worth remembering that the consumer has been strong, and HD and LOW are retail companies too.
In the chart below, you can see that LOW has been in a steady uptrend for a while now, hitting resistance just under $127 last week.
Daily Chart of Lowes Companies, Inc. (LOW) — Chart Source: TradingView
The market pulled back yesterday, and LOW followed along, but how long will it be before it starts rising again? If it reports strong earnings, it may get a boost back up to resistance at $127 before profit taking kicks in.
I would expect the stock to struggle with resistance in the short term, then start rising again in the coming months.
With a calendar call credit spread, we can sell a call against the stock for income now while also taking a longer-term bullish position. Because the stock formed a top at $127, I don’t think it will rise above $130 before earnings. So, I’ve set the short option strike price at $130.
If we want to collect income while taking this position, we need to buy a cheap call option, and the far out-of-the-money June 19th $145 call options will suffice.
Using a spread order, sell to open the LOW Feb 28th $130 call and buy to open the LOW June 19th $145 call for a net credit of about $0.15.
Note: Be sure you are selling to open the weekly LOW options that expire on Friday, Feb. 28, 2020. Be sure you are buying to open the monthly LOW options that expire on Friday, June 19, 2020.
About Calendar Call Credit Spreads
A calendar call credit spread involves writing (selling to open) an option and simultaneously purchasing (buying to open) an option with a different expiration date and strike price in the same underlying security. The position, or leg, of the spread trade that you sell gives you a cash credit to your trading account. The option you buy limits your risk, lowers your margin requirement for the trade and gives you a chance to collect more income if the underlying security rises in the future.
This is a trade in which you want the underlying share price to stay below the lower strike price of the spread through the first expiration. In this case, we want LOW to stay below $130 through the Feb. 28 expiration.
InvestorPlace advisor Ken Trester also brings you Power Options Weekly, which delivers 5 new options trades and his latest trading advice to you each Friday. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.