Trust, But Verify: Home Depot
Dragonfly Capital | Oct 22, 2014 12:34AM ET
Stocks have made some major moves since the lows of the Droptoberfest™ selloff. The S&P 500 itself has moved over 120 points in 5 days. That is a lot. But is it safe to put your money back to work? Can you trust this market? As President Ronald Reagan used to say, “Trust but verify”. Let’s look at Home Depot (NYSE:HD) to see how to do that.
Home Depot is one of many stocks that have rebounded strongly. Four strong candlesticks higher and it is all the way back at the prior high. The RSI is back in the bullish zone and the MACD is about to cross up. All is looking great. Except that there are some gaps in the move higher. Oh, and the volume is light and actually falling off. Hmmm. You could keep your position and raise you stop as it sits near resistance. But that won't help if Germany sells off 3% overnight. A better way is to put on a collar.
A collar is nothing more that selling a Covered Call and then buying a Put for downside protection. For Home Depot, a break over the resistance zone would target a move to 100, so consider selling the November 100 Calls. The downside protection is a shorter term issue, so for that, look to the October 31 Expiry, and maybe buy the 94/90 Put Spread. This gives protection over the next week, against a 4% down move while you sleep. If the stock has not dropped by then, your profits have been building as it broke to new highs, a good thing.
The 3 option combination, selling the November 100 Calls, buying the October 31 Expiry 94 Puts and selling the October 31 Expiry 90 Puts, cost less than 60 cents. In this way you continue to own the stock, and trust the move. But you also have protection, to verify it.
Disclosure: The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
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