beat earnings estimates last week and raised its outlook, but shares have traded lower in the week since, and we have a price-based sell signal consistent with the short-term trend (figure 1, middle panel)
We can use a vertical call credit spread to express this bearish price outlook. By selling an out-of-the-money call spread, we will stand to make a profit, even if the price forecast proves incorrect. As long as the stock is below the short strike of the spread at expiration, we will keep the credit received.
Implied volatility is modest here -- the September 90 calls are priced at about 17.8%, which is roughly in line with the 60-day historical volatility of the stock. We can sell the 90 calls and buy the 92.5 calls for cover for a net credit of about $0.45, which means we're risking $2.05. The trade will be profitable as long as UTX is below $90.45 at September expiration.
This is already a risk-defined spread, which makes it easy to size positions so that you are comfortable with the risk involved as I explain in the video below. However, as an added defense I prefer to exit spreads based on this price signal if the underlying closes beyond the short strike of the spread. In this case, we'll exit the trade if UTX closes above $90.
Trades: Sell to open UTX September 90 calls for $0.84 and buy to open UTX September 92.5 calls at $0.39.
At the time of publication, Jared Woodard held no positions in the stocks or issues mentioned.
If you liked this article brought to you by Options Profits and want to explore more of the product, please CLICK HERE for a 14-Day Free Trial.
Jared Woodard is the principal of Condor Options, a research and trading firm in New York. With over a decade of experience trading options, futures, and equities, he has been quoted in various media outlets including The Wall Street Journal, Reuters, Bloomberg, and Financial Times Alphaville. Jared is the author of Options and the Volatility Risk Premium and Iron Condor Spread Strategies, both published by FT Press.
Jared is a registered commodity trading advisor at Clinamen Financial Group. He is a founding and contributing editor of Expiring Monthly: The Option Traders Journal, and is a Ph.D. candidate at Fordham University