DocuSign (DOCU) is set to report earnings on Thursday after the close. Here’s how to set up a short-term bull put spread on DOCU stock if you think it will have a positive reaction to earnings.
No wonder it’s found a home on both the Leaderboard and SwingTrader premium products as well as the IBD 50, IBD Big Cap 20 and IBD Sector Leaders Lists. The entry for Leaderboard came after the last earnings report. DOCU stock moved up around 20% in a single day. And it recently tested the 10-week moving average line.
Setting Up A Bull Put Spread On DOCU Stock
To determine what kind of option trade to create, you have to start with your expectations.
Let’s use two assumptions.
- First, we think DOCU stock will stay within its expected range after its earnings report.
- Second, the response to the earnings report is likely to be positive.
We’ll start with putting some numbers behind the expected range of DOCU stock. We’ll use the Sept. 3 expiration since that is the earliest expiration after the Sept. 2 earnings report.
Adding the at-the-money put and call, we see that the expected range is 8%.
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Now that we know the expected range, let’s find a bull put spread with a short strike roughly 8% below the stock price. Yesterday, DocuSign stock closed at 303 so we’ll use the 275 strike.
We create the bull put spread by selling the 275 put and buying the 270 put with the same expiration date of Sept. 3.
This spread was trading for around 76 cents per share yesterday, but with the stock dropping today, it’s closer to $1. That means a trader selling this spread would receive $100 in option premium for the trade.
The maximum reward for the option trader is the $100 in option premium. If DOCU stock closes above 275 at expiration, both options expire worthless and you keep the full premium.
The risk would be the difference of the strike prices minus the credit received. That calculates out to a maximum risk of $400. If DocuSign stock closes below 270 at expiration, you lose the full amount.
Managing The Option Trade
The $100 profit potential with $400 risk represents a 25% return on risk between now and September 3. That is, if you achieve the maximum profit.
The 25% return in just a few days is enticing. But don’t forget the downside.
The possibility of losing 100% is also very real. As such, this style of trade is only for traders with high risk tolerance and you should use appropriate position sizing.
The break-even point for the bull put spread is with DOCU stock at 274. That’s calculated as the short strike of 275 less the 1.00 option premium per contract.
Keep in mind, there is little room for adjustment with short-term trades, such as this, held over earnings. That adds to the higher risk of the trade.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ.
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