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CVS Health (CVS) is due to announce before the open next Wednesday.
So, as always, let’s go through the exercise of looking at a potential trade and its associated mechanics to see if CVS is offering a decent trading opportunity this time around.
Here is an early look at a potential earnings trade for next week. Hopefully this helps a few of you, particularly those who are new to earnings trades, with the mechanics of a trade.
Iron Condor Earnings Trade in CVS Health (CVS)
Again, CVS Health (CVS) is due to announce before the open next Wednesday. So, let’s use a risk-defined options strategy like an iron condor.
The stock is currently trading for 99.03.
The next item is to look at CVS’s expected move for the expiration cycle that I’m interested in.
The expected move or expected range over the next 14 days can be seen in the pale, orange-colored bar below. The expected move is from 93.5 to roughly 104.5, for a range of $11.
Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of 93.5 to 104.5.
This is my preference most of the time when using iron condors.
If we look at the call side of CVS for the May 13, 2022, expiration, we can see that the 108 call strike offers an 89.78% probability of success and the 109 strike offers us a 92.30% probability of success. For this example, I’m going to sell the short call at the 108 call strike and define my risk with the 113 call strike. By choosing the 113 call strike to define my risk, I know that there is less than a 5% chance that I will take a max loss on the trade.
Now let us move to the put side. Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 93.5. The 90 put strike, with an 84.67% probability of success, works as our short put strike. The 90 put strike defines our probability of success on the downside. I’m going to define my risk by choosing the 85 put strike with a 92.74% probability of success. This means we have less than a 7.5% chance of taking a max loss on the downside.
We can create a trade with a nice probability of success if CVS stays between our 18-point range, or between the 108 call strike and the 90 put strike. Our probability of success on the trade is 89.78% on the upside and 84.67% on the downside.
I like those odds.
Here is the trade:
Sell to open CVS May 13, 2022, 108 calls
Buy to open CVS May 13, 2022, 112 calls
Sell to open CVS May 13, 2022, 90 puts
Buy to open CVS May 13, 2022, 85 puts for roughly $0.53 or $53 per iron condor
Our potential return on the trade: 11.9%
Our margin requirement is $447 per iron condor.
Again, the goal of selling the CVS iron condor is to have the underlying stock stay below the 108 call strike and above the 90 put strike immediately after CVS earnings are announced.
Here are the parameters for this trade:
- The Probability of Success – 89.78% (call side) and 84.67% (put side)
- The maximum return on the trade is the credit of $0.53, or $53 per iron condor
- Breakeven level: 89.47 – 108.53
- The maximum loss on the trade is $447 per iron condor. Remember, we always adjust if necessary, and always stick to our stop-loss guidelines. Position size, as always, is key.
One other important note: I prefer to make these trades the day before earnings are announced, so I would expect to see the premium a bit lower than it is now due to decay. So premium could be an issue at the time of the trade. But I like to see where potential trades stand the week to a few days prior, so I have a good understanding of what stocks look appealing for a potential trade around earnings, which is why I go through this exercise with the stocks on my weekly earnings watch list.