Adjusting an existing trade to prepare for an Earnings Report

A much-anticipated earnings CATreport on Monday from $CAT is the subject of this post. I have a position in the Fab 5 basket of stocks for $CAT (purpose is for the $100 Roll trade) and wanted to illustrate one way to make an adjustment so that the Risk to a trade is managed properly. In addition, I will show how an adjustment for many different reactions can be taken into account and structured for. Here are the details to the initial trade:

  • I am Long the February 95 Call
  • I am Short the February 100 Call (thus the 2 pieces make a Call Spread)
  • I am Short the February 87.5 Put (premium collected to help lessen the cost of the above Call Spread)
  • This is considered a Risk Reversal trade

On Friday I began to evaluate the trade by changing the lens on my view, adjusting my perspective based on recent information that was putting pressure on price. Based on this information and what I saw being reflected in the chart, as well as my plan to protect against any significant downside risk, I elected to make the following adjustments:

CAT_earningsLet me break it down:

  • I bought back the short 100 February Call and sold the February 1 weekly 95 Call. This converts from a Call Spread to a Call Calendar.
  • I bought the February 1 weekly 87.5 Put to protect the short one I have in the February monthly chain. This creates a Put Calendar, but one I am short.

A few scenarios that can occur, and how I would work the trade accordingly:

1) The stock moves down after the report and hangs out near the 87.5 strike Put. I will be glad I own Puts for next week and will deal with accordingly. In this scenario it is likely the short 95 Call can be bought back on the cheap, thus collecting the bulk of premium from the sale. Ideally from here, the play is for a price recovery back up to Friday prices to get value from the long February monthly 95 Call. If this occurs, the plan would be to create a Call Spread again to lower the cost further for the Long 95 Call.

2) The stock moves down after report into the Gap Fill area (92.95 to 89.80). In this scenario it is likely the short 95 Call can be bought back on the cheap, thus collecting the bulk of premium from the sale. Ideally from here, the play is for a price recovery back up to Friday prices to get value from the long February monthly 95 Call. I would manage the Put Call side as appropriate, can wait until Friday if desired.

3) The stock stays in current price area (97.73 to 94.66). In this scenario it is less likely the short 95 Call can be bought back cheaply – near premium collected or lower is ideal if given the opportunity. Ideally from here, the play is for a minor dip and then price recovery back up to (and above) Friday prices to get real value from the long February monthly 95 Call. Manage the Put Call side as appropriate, can wait until Friday if desired but would imagine can take these 2 pieces off and keep a good portion of the premium.

For those that are more visual, let me add a graphic that shows the plan and how it could play out in these scenarios:

CAT_scenarios

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