Humana) reported earnings this week and the market punished it dramatically. But was the sell-off too severe? This column addresses a buy opportunity by examining a long call butterfly spread in Humana stock.
The company and giant in health insurance also pulled 2025 guidance. That said, Humana rarely puts in a candle stick of this magnitude on its chart that does not see the stock retrace such losses. Thus, the upshot holds that a potential test of 400 is quite possible if the traders in this stock behave as they have in the past.
My estimation? Humana stock will bounce into 400. Plus, that might serve as a resistance zone to watch.
The Market Background
We are finishing a week with Federal Reserve Bank presidents in a quiet period. Next week's FOMC meeting will bring stronger positioning from the news on interest rate news. For yet another week, higher prices higher still appear more favorable in the overall bullish context of the market with one caveat.
We have got to keep a closer eye on the 5-year Treasury bond auctions. The results of these auctions have brought sellers into the broad indexes.
But the main takeaway holds: Wait for the weekly pullbacks to go long.
Humana Stock: Setting Up The Trade
The long call butterfly spread is a neutral to bullish position. It estimates that prices will rise over the longer term but will also stall out at the round level of 400 in order to deliver stellar results.
The long call butterfly spread for HUM stands as follows:
- Buy to open 1 HUM May 17-expiring call with a 370 strike price
- Sell to open 2 HUM May 17 400 calls
- Buy to open 1 HUM May 17 430 call
When To Close The Trade
Total debit of $5.15 per set of contracts, based on recent trading, for this trade in Humana stock means the break-even cost stands at 375.15. That is, take the price of the first long option strike and the total net cost of the option.
The ideal strategy result gives us four choices to exit the trade. One, sell the entire butterfly spread once it carries an acceptable profit. This would be 50% to 100% for me. But price behavior will determine the move.
Two, sell the entire butterfly spread once it hits your loss threshold — in this case, -50% for me.
Three, sell the entire spread when prices in Humana stock test the middle strike price. And finally, sell the long call spread when the middle strike tests, and let the short side erode to expire worthless. This strategy requires increased skill level and attention. Why? It opens the trader to additional risk.
Stock hunting using fundamental and price strength within the IBD methodology is where I firmly plant myself under the backdrop of the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
Identify Key Chart Levels
The goal of taking the butterfly trade is to gain exposure to profit but to significantly limit loss if we are incorrect.
Options sellers are positioned to win in two ways — the stock does nothing, or the stock moves within the ranges, so we use this concept to minimize the risk of market exposure.
Monthly support zone sits near 350. Resistance sits near 410. If we see some sharp dips, we will be in a position to potentially add to the position as long as market indicators show increased probabilities of more upside. This will increase your risk, so think this through. Be patient in the current flow and realize that there are some macro events that could result in volatility.
Understanding The Butterfly Spread In Humana Stock
Let's also consider these scenarios:
- Stock dips lower but does not break 350 for more than three days and shows itself as favorable to the traders looking for longer-term growth. We should look for bounces in the days following to confirm strength of the chart.
- Humana stock grinds higher much earlier in the cycle and the option position increases in value by more than 100%. We could choose to sell the entire position and quickly take the gains, freeing up more capital to trade.
- Shares grind higher. They test or breach 400 but immediately retreat. This suggests traders are not willing to pay more for the stock at the present time. This is ideal if it occurs in the near term and into the May expiration strike
- Humana stock breaks down on volume for more than three days, breaking our personal risk thresholds. We exit the trade.
Consider closing or adjusting this trade if the stock creeps past 410 as we approach May expiration, because we will see reduced returns upon a move to higher prices.
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully. Also, be patient and allow price action to move around a range of your stops.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on Twitter and Stocktwits at @AnneMarieTrades
