Earnings season is winding down but it isn't over. Adobe is due to report earnings on Thursday after the closing bell, and the options market is pricing in a 7.5% move in either direction. Adobe stock stayed above the lower expected range following four of the last six earnings announcements.
If we make the assumption that it can do it again, a bull put spread can be set up to profit while keeping the risk defined.
It's not our first use of this strategy. You could also check out these former columns with a bull put spread on Nvidia and Salesforce earnings to see how well this strategy worked in those cases.
Estimating An Earnings Move
If you're wondering how we can expect the Adobe stock price to stay within 7.6% of the current price, look no further than the options market for answers.
Taking the at-the-money put and call for the nearest expiration after earnings gives you a pretty good approximation for the expected move. You can divide that number by the stock price to turn it into a percentage.
At yesterday's close, the two premiums added together traded around 43 points, or 7.5% of the stock price at 570. This gives you a range in which Adobe stock is likely to trade. Of course, there are no guarantees and it doesn't tell you direction.
Setting Up The Bull Put Spread On Adobe Stock
Now that we know the expected range, let's find a bull put spread that has the short strike roughly 7.5% below the stock price.
Going 43 points down, we can sell the March 15 put with a 525 strike. Then we'll buy the 520 put with the same expiration to create the bull put spread. Buying a put will eat into the credit received, but it offers us protection below 520 in case we are wrong.
This spread is trading for around 90 cents this morning. That means a trader selling this spread receives $90 in option premium. The maximum risk is calculated by taking the difference in strikes and subtracting the premium received. In this case, the maximum risk is $410.
That represents a 22% return on risk between now and March 15 if ADBE stock remains above 525.
If ADBE closes below 520 on the expiration date, the trade loses the full $410.
How To Exit Intel Stock Option Trade
The break-even point for the bull put spread is 524.10, which is calculated as 525 less the 90 cents option premium per contract.
There is little room for adjustment with short-term trades such as this held over earnings.
A 22% return in a few days would be nice, but the possibility of losing 100% is also very real.
As such, this style of trade is only for traders with a high-risk tolerance.
If Adobe stock ends below 520, long-term investors could consider taking ownership of the 100 shares and selling covered calls against it.
According to IBD Stock Checkup, Adobe is ranked No. 2 in its industry group. It has a Composite Rating of 80, an EPS Rating of 96 and a Relative Strength Rating of 71.
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 X/Twitter at @OptiontradinIQ
