Call Spread - Home Depot

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Date: 23rd February 2007
Strategy: Call Spread
Underlying: Home Depot (NYSE:HD)

Background and Trade Setup

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The chart looks ok...it's been trending nicely the last 6 months or so and it has just come off a little in price. The pull backs of late have been a good indication that the stock will resume the uptrend (perhaps this is one of the rules of Travis's system).

Also, I took a look IVolatility and noticed that both the implied volatility and the historical volatility are currently hovering around one year lows.

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Both of these factors make for a good bullish options play.

I first thought of a 40/42.50 strike call backspread, which is currently trading at $105 credit. With this strategy, the potential gain is unlimited and I will have limited downside. However, the gains won't kick in until the stock is trading around $44. And that is only the breakeven point. But, I would have profit potential on the downside too, which kicks in around the $41 mark. In either case, I'm not confident with the backspread in this case.

So, I ended up taking a Bull Call Spread position. Buying 1 $40 strike call option and selling 1 $42.50 call option means this spread is trading around $115 debit.

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Take a look at the payoff graph of this strategy from Option-Price.

The maximum gain on this spread would only be $135 (17%) if the stock makes a good rally. But this is only when the stock is around the $43 mark. And profits kick in at $41.15, which is only 0.19 cents (0.46%) away from the current market.

There is no upside to this strategy if the market comes off and the maximum loss for this spread is $115 per option spread. Let's see how it goes. Next ->>