Today I am going to share an extremely sophisticated option strategy traded on Home Depot (HD). This trade brought in a remarkable 18% profit in 11 days.
From January 2023, I started monitoring the Home Depot chart. Around the $340 mark there was a significative resistance level which could potentially hold for a little while.
When trading options strategies it is key to have clarity about the timeframe of the trade. If you are trading options for the short term (trades which last on average between 15 and 45 days), then you want to choose your options strategies and pick the best possible strikes according to your expectations in that specific time frame.
Opening Up a Bearish Volatility Trade
For instance, in the specific case of Home Depot, I believed that the stock could go eventually up in the long term. If I had a substantial amount of money to invest in a stock for the long term, I could have allocated some of it to Home Depot and hold it for an unlimited amount of time. However, as an option trader I am aware of the possibilities that options offer in any market condition. And this opens for me different scenarios, the ability to work on different time frames and benefit from the leverage and flexibility provided by options.
With Home Depot trading in a range with a resistance level at the $340 mark. The conditions made me believe that in the short term the underlying security could drop slightly in price and experience a rise in implied volatility.
These circumstances created the conditions for using an advanced option strategy known as the Diagonal Spread. This is a more sophisticated strategy as it involves combining options of the same type (either calls or puts), but with different strike prices and different expiration dates. However, with a more complex strategy also comes more opportunity. In fact, a diagonal spread offers the chance to benefit from a directional trend, time decay and changes in implied volatility enhancing the chances of success.
On Friday the 3rd of February 2023, I opened a Put Diagonal Spread - slightly bearish strategy – by purchasing 1 contract of the $350 Put Option with expiration June 16th, 2023, and selling 1 contract of the $325 Put Option with expiration March 17th, 2023.
I had an initial entry debit or max risk of $1963 with a maximum profit potential of $1167. That’s a potential 60% risk/reward ratio in 42 days. From that day ahead, the stock started trading downwards and exactly into its trading range.
Closing the Strategy to Avoid Further Risks
On Tuesday the 14th of February, I decide to get out of the trade with a profit of $330 when the underlying security was trading around $318. It is $14 down from where it was trading when the trade was started. Despite there were still 31 days left on the strategy which could bring in more profit, in my opinion conditions had changed as the stock did not experience the increase in implied volatility I was expecting. On top of this, the earnings release was due in 7 days and decided not to take further risks as this event could create substantial changes in the behaviour of the stock.
At times as an option trader you need to be able to trust your guts and have the courage to change your mind about a trade if conditions have changed and you do not feel comfortable anymore.
Hope you found this Diagonal Spread trade interesting.
I’ll see you on my next release of the Options Trading Diary.