After a couple of distribution days in close proximity, it might be prudent to take a little bit of a more defensive stance in the short term. Enter Trane Technologies. This trade examines a short calendar spread using call options in TT stock.
Looking at the stock market, rotations by major indexes to key moving averages look likely. From a seasonality perspective, August also tends to be a weaker month than July. So, broad knowledge of this could see some profit taking. With this as the backdrop, we will choose strong stocks that could pull back into clean support lines and lift again.
The fade on Thursday served as a reflexive move anchored to the Bank of Japan's stance on their interest rate policies. Yet, irrespective of the reasons why stocks behaved that way, the action did allow us to see where strength holds. One of those sectors: consider the industrial space.
If you've ever seen industrial or high end climate control systems, you will know the Trane Technologies name well.
Trane will report Q2 results on Aug. 2 before the market opens. So this position in TT stock will need your attention to deliver optimal results.
IBD Stock Checkup shows a Composite Rating of 94 for TT stock — respectable within a field of strong competitors like Parker Hannifin and others.
TT Stock Today: The Trade Setup
As we look at the option toolbox, we find the short calendar spread allows for a potential beat into the earnings release, and then a fade before resumption of trend.
Let's consider this setup over the next six weeks:
- Buy to open 1 TT Aug. 18-expiring call with a 200 strike price
- Sell to open 1 TT Sept. 15 200 call
The short calendar formation allows us to take advantage of sideways-to-slight upside motion in the very near term. This trade in TT stock also benefits from a fade of prices into the September time frame. This structure differs from other option positions posted. How? It posts a credit and has risk exposure after August's expiration.
A trader in this case will receive a total credit of $1.90 per spread, based on recent trading. However, keep in mind that this trade holds an unlimited risk after the expiration of the August strike. Therefore, we will mitigate that in the notes below.
The break-even price (before commissions) is $198.10 — the credit from the short call strike.
Defending The Trade
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.
This spread holds a long call in the front month and a short call in the forward month. The credit of $1.90 can be used to fund further price development.
Again, the break-even price for this spread is $198.10.
To manage this trade in TT stock, let's first identify key chart levels.
The weekly resistance zone sits near $207 and support sits near $185, so this anchor needs to hold for the trade thesis to stay intact. If prices fade, the spread will appreciate in value and if prices rise, the spread will depreciate in value (generally speaking). Here's where you can build strength in option execution.
Scenarios To Consider For TT Stock
What could happen? Please take a breath here and read one step at a time.
The majesty of the options market is that it creates remarkable power that can be harnessed. Don't feel overwhelmed. If it is too much to consider, just choose the simple options as stated in the first two bullets.
- TT stock spikes lower after the earnings release. You can collect 50% or more of the credit collected, and you leave the trade.
- Shares spike higher after the earnings release. You buy the position back before the August expiration with the defined risk parameters that suit you.
- The stock spikes higher after the earnings release on Aug. 2. In this scenario, I will sell the long Aug. 18 200 strike call, then will buy the 210 call in September. This will create a short call spread that will naturally erode as prices in TT stock slog between 200 and 210.
- TT stock spikes higher after the earnings release on Aug. 2. In this alternate scenario, I will sell the long Aug. 18 200 strike call and buy the 210 call expiring in December. This will create a calendar spread that will create unlimited upside opportunity and allowing the potential sale of additional strikes in October and November, once those chains have been established. Overall, this plan may further minimize your total cost of the option.
More Nuances To Absorb
- Without any adjustment, if the stock price moves markedly higher into expiration on Aug. 18, you can choose to be assigned the stock. This resulting in a covered call position in TT stock, but with a covered strike close to the share price.
- Without any adjustment, if TT stock moves markedly lower into August expiration, the long call will expire as worthless, capturing the total credit of $1.90. But then you will be naked short. As we know, this outcome is generally ill advised as it opens unlimited risk.
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully. Plus, 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
