McDonald's is currently the most overbought stock in the Dow Jones Industrial Index and is also trading at its highest price-earnings ratio since at least 2010.
Today, I'm looking at a trade that takes advantage of the volatility skew around this week's earnings report and will also perform well if MCD stock experiences a slight pullback.
I'm thinking McDonald's stock might pull back to 285 this week and will look at a bearish calendar spread at that strike price.
A calendar spread is a trade that involves selling a short-term option and buying a longer-term option with the same strike price.
Traders typically use call options unless the trade has a bearish bias. In that case, they would use puts.
Estimated Return $350
Here's the trade I'm looking at:
Based on Friday's closing prices, traders could sell the April 28, 285 strike put for around $1.45, then buy the May 12, 285 strike put for around $2.20.
That results in a net cost for the trade of $75 per spread for a block of 100 shares, and that is the most the trade can lose.
The estimated maximum profit is around $350, but that could vary depending on changes in implied volatility.
The idea with the trade is that if MCD stock trades down around 285 after Tuesday's earnings, the calendar spread will increase in value, allowing the trade to be closed for a profit.
Trade About The Same As Shorting 8 Shares
The position starts with a delta of -8, meaning the exposure is roughly equivalent to being short eight shares of MCD stock. But this will change as the trade progresses.
According to the IBD Stock Checkup, MCD stock is ranked No. 17 in its group and has a Composite Rating of 78, an EPS Rating of 73 and a Relative Strength Rating of 87.
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
