Over the last few weeks, we have been looking at the concept of expected range for a stock over an earnings announcement. Etsy has stayed within the expected range following five of the last six earnings announcements.
Etsy stock is showing a good Composite Rating of 90, a best-possible EPS Rating of 99 and a Relative Strength Rating of 76. The stock appears to be fashioning the right side of a new, large base, such as a cup pattern. A potential handle may form, too.
So, let's analyze how we can structure an option trade that fits the view that 1) we think Etsy stock will stay within the expected range; and 2) the response to the earnings report is likely to be positive.
Etsy is slated to report quarterly earnings on Aug. 4.
Etsy Stock: Fashioning A Bull Put Spread
Taking the at-the-money put and call for the Aug. 6 expiration, we can see that the expected range is 10.1%. Now that we know the expected range, let's find a bull put spread that has the short strike roughly 10% below the stock price.
Selling the Aug. 6-expiration, 180-strike put and buying the 175 put would create a bull put spread.
This spread was trading for around 75 cents Wednesday. So, a trader selling this spread would receive $75 in option premium for a 100-share block, and would have a maximum risk of $425.
That represents a 17.7% return on risk between now and Aug. 6 if Etsy stock remains above 180.
If Etsy closes below 170 on the expiration date the trade loses the full $425.
The break-even point for the bull put spread is 179.25; you can calculate this as 180 less the 75-cent option premium per contract.
Higher Level Of Risk In This Trade
There is little room for adjustment with short-term trades such as this one in Etsy stock held over earnings. A 17% return in a few days would be nice, but the possibility of losing 100% is also very real. As such, this style of trade is only for traders with a high risk tolerance.
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
