Home Depot stock dropped more than 3% Tuesday, closing near its session low and breaking below its 21-day and 50-day moving averages. That paints a fairly negative picture. Especially since the stock also remains below its 200-day moving average.
So let's look at a bear call spread that assumes Home Depot will struggle to get back above the 370 level between now and mid-August. This is similar to Tuesday's column on Snowflake.
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.
The strategy can be profitable if the stock trades lower or sideways — and even if it trades slightly higher — as long as it stays below the short call at expiration.
Maximum Gains And Losses
An Aug. 15 expiration on a bear call spread for Home Depot stock using strike prices of 370 to 375 traded around 1.60 a share this morning. Traders selling the spread would receive $160 in option premium on a 100-share contract, which is also the maximum possible gain. The maximum loss would be $340.
That represents a potential return of 47% between now and Aug. 15. The spread achieves the maximum profit if Home Depot stock closes below 370 on Aug. 15, in which case the entire spread expires worthless, allowing the trader to keep the $160 option premium.
The maximum loss comes if Home Depot closes above 375 on Aug. 15, which would see the premium seller lose $340 on the trade.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy, and you always know the worst-case scenario in advance. A stop-loss trade could be set if Home Depot rises above 370, or if the spread value increases to 3.20 from 1.60.
Ratings For Home Depot Stock
Bear call spreads can be a good way to potentially generate some income while the market consolidates recent gains.
According to Investor's Business Daily's IBD Stock Checkup, Home Depot stock ranks second in its group. It has a Composite Rating of 48, an Earnings Per Share Rating of 62 and a Relative Strength Rating of 27.
Home Depot is due to report earnings Aug. 19, so this trade should not have any earnings risk.
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, and is conservative in his style. He also believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ.
