Option Trade of the Week – Stuck in Neutral
April 18, 2023
Here is your Option Trade of the Week, as included in this past weekend’s Saturday Report for our Terry’s Tips Insider Members. This stock hasn’t done much this week, so you can enter this trade at about the same price as my Insiders. Good luck with the trade!
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Stuck in Neutral
Used-car retailer CarMax (KMX) is a stock that attracts a wide range of opinions. This week, KMX reported earnings that had something for both bulls and bears. On the bullish side, earnings per share (EPS) more than doubled the consensus estimate. But the bears will point out that net income fell 57% from a year earlier. Revenue declined 25% and fell far short of expectations. And the company pointed out that “headwinds remained due to widespread inflationary pressures, climbing interest rates, tightening lending standards, and prolonged low consumer confidence.” Even so, KMX affirmed its long-term financial targets.
Analysts were all over the road with their reactions. Some pointed to the success of KMX’s cost management strategy. Others reiterated the headwinds the company itself discussed. If there is a consensus, it appears that the short to neutral term will be challenging, while the longer-term outlook is encouraging.
KMX’s chart also has some headwinds in the form of the 200-day moving average. The stock hasn’t closed a day above this declining trendline since December 2021. Rally attempts in August and February were stopped in their tracks by the 200-day. And so was the post-earnings pop this week.
This trade is a bet that the short-term road will be bumpy for KMX and that the 200-day will continue to keep the stock in a six-month trading range bounded on the upside by the 75 level. This is also where the 200-day currently resides.
If you agree that KMX will struggle under the weight of its 200-day moving average (blue line) for the next few weeks, consider the following trade that relies on the stock staying below $75 (red line) through expiration in 7 weeks:
Buy to Open the KMX 2 Jun 78 call (KMX230602C78)
Sell to Open the KMX 2 Jun 75 call (KMX230602C75) for a credit of $0.70 (selling a vertical)
This credit is $0.05 less than the mid-point price of the spread at Friday’s $69.46 close. Unless KMX plunges at the open on Monday, you should be able to get close to that price.
The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $68.70. This trade reduces your buying power by $300, making your net investment $231.30 per spread ($300 – $68.70). If KMX closes below $75 on June 2, both options will expire worthless and your return on the spread would be 30% ($683.70/$231.30).
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