Home Depot (HD - Get Report) stock slumped on Tuesday despite a better-than-expected earnings report. Technical analysis shows that shares will rebound, and investors can profit from such a move by using stock options.
The hardware and home-improvement retailer said that earnings per share were $1.44, smashing the analyst consensus of $1.36. Revenue increased 9% year over year, to $22.76 billion from $20.89 billion in the same quarter a year earlier.
In spite of this positive news, Home Depot's stock price fell Tuesday, moving down below support on heavy volume. This presents a strong bullish signal.
The volume spike is a strong reversal signal by itself, and Tuesday's volume was the largest in any single session in the past six months. It also confirms the bullish signal found in the stock's move below support. Home Depot has been trading in a narrow consolidation range between $133 and $136. This has been in effect since the beginning of April. In such situations, lacking any strong signals to the contrary, moves outside the range tend to reverse very quickly. So we should expect Home Depot's stock price to move up once again to more than $133.
With this price pattern in mind, and given the likely reversal confirmed by volume, we looked at the May 27 weekly options, which expire in nine days. The May 27 put option with a $131 strike price had a bid on Tuesday of 1.37. Including trading costs, this option can be sold for a next credit of about $128. Given the price pattern and fast expiration term for this, expect time value to decay rapidly over the next nine days. The uncovered sale of a put has identical market value to the covered call. Because we expect the underlying stock's price to move higher, this is a sensible trade following the combination of positive earnings with downward price movement.