Home Depot is currently the most oversold stock in the Dow Jones Industrial Index when looking at the relative strength index indicator. Traders might consider taking some bullish exposure on Home Depot, using options in a limited risk way.
One way to do that is by using a bullish butterfly spread. Butterfly spreads involve three different option strikes, all within the same expiration date, and can be created using either calls or puts.
By trading a butterfly with a bullish bias, we can place the trade cheaply and have a large potential payoff.
Assuming we have a price target of 410 for Home Depot stock within the next few weeks. Let's look at how we can set up a bullish butterfly based on those parameters.
How The Butterfly Takes Wing
First, you buy one Nov. 21, 400 call at $10.10 a share. Then sell two Nov. 21 410 calls at $6.40. And then buy one Nov. 21 420 call at $3.80
This trade only costs around $110 per spread but has a payoff potential much higher than that. The ideal scenario is for Home Depot stock to be right around 410 at expiration on Nov. 21.
The maximum loss on the trade is equal to the premium paid of around $110 per contract of 100 shares. This would occur anywhere below 400 or above 420 a share.
The maximum potential profit on the trade is $890. This is calculated by taking the width of the butterfly, which is 10 times 100 less the $110 premium paid. At expiration, the break-even areas are at 401.10 and 418.9. Profits increase between those prices until it hits the max profit at 410.
Taking a low-risk trade like this can be one way to gain exposure to a bounce in Home Depot stock while also risking little capital.
Home Depot Stock: Earnings Due In November
Home Depot is due to report earnings in mid-November, so this trade would have earnings risk if held to expiration.
Investor's Business Daily gives Home Depot stock a Composite Rating of 52 out of a best-possible 99, an Earnings Per Share Rating of 52 and a Relative Strength Rating of 42. According to IBD Stock Checkup, Home Depot also ranks second in the Retail/Wholesale-Building Products group. Further, the group rates 145th of the 197 industry groups covered by IBD.
This long straddle trade on Advanced Micro Devices from last week was a big winner and can be closed early.
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.
