Target Option Trade: Selling High Volatility Before Earnings

Selling put options before a company's earnings announcement can be a valid strategy for options traders seeking to capitalize on higher than normal volatility.

One of the primary reasons traders may consider selling a Target (TGT) put option before their earnings announcement on Friday is the elevated implied volatility. Earnings reports can trigger significant price movements, and this volatility results in an increase in option premiums. By selling the put option before the announcement, traders aim to capitalize on the inflated premium, especially if they believe that the stock will remain above the strike price by the option's expiration date.

Before delving into the strategy, let's quickly recap what it means to sell a put option. A cash-secured put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock. The goal is to either have the put expire worthless and keep the premium or be assigned and acquire the stock below the current price.

Selling put options is an easy place for investors to start with options. They are like a covered call and are pretty easy to understand once you know the basics.

Traders selling puts should understand that they may be assigned 100 shares at the strike price.

Potential Benefits

Selling put options allows traders to collect premium income upfront. If the options expire worthless, the seller keeps the entire premium as profit.

The premium received can lower the breakeven point for the trade. If the stock price drops but remains above the breakeven point, the seller still profits.

Traders who are bullish or neutral on TGT can benefit from the increased volatility leading up to the earnings report.

After the earnings announcement, implied volatility tends to drop significantly, reducing option premiums. By selling options before the announcement, traders can take advantage of this implied volatility drop.

Potential Risks

If the stock price falls below the put option's strike price, the seller may be obligated to buy TGT shares at a higher price than the current market value.

While the profit potential is limited to the premium received, losses can theoretically be unlimited if the stock price drops significantly.

An earnings surprises could result in a sharp drop in the price of TGT stock.

Selling a TGT Put Option Before Earnings

A trader selling the August 21st $140-strike put on TGT would receive around $126 into their account, which would be theirs to keep. Due to the bid-ask spread, the actual amount could be slightly higher than this.

If TGT falls below $140 by August 21, they would be required to buy 100 shares at $140. The effective net cost of the position would be $138.74, thanks to the option premium received.

That is 8.13% below Monday’s closing price.

If the stock stays above $140 at expiry, the put expires worthless, leaving the trader with a 0.9% annualized return on capital at risk.

That works out to be 82.9% annualized.

This table shows other potential put selling candidates on Target for the August 21 expiration.

On the Target volatility charts, we can see the term structure shows that implied volatility is very high for the expiration immediately after earnings.

This 84% volatility means high option premiums when compared to longer-term options which only have volatility of around 35%.

Company Details

The Barchart Technical Opinion rating is a 100% Buy with a Strengthening short term outlook on maintaining the current direction.

Long term indicators fully support a continuation of the trend.

Relative Strength just crossed below 70%. The market has dropped from overbought territory. Beware of a potential mean reversion.

Target Corp. has evolved from just being a pure brick-&-mortar retailer to an omni-channel entity. It has been modernizing supply chain to compete with pure e-commerce players. Its acquisition of Shipt to provide same-day delivery of groceries, essentials, home, electronics as well as other products. Target provides an array of owned & premium branded goods ranging from household essentials and electronics to toys and apparel for men, women and kids. It also houses food and pet supplies, home furnishings and d'cor, home improvement, automotive products and seasonal merchandise. It also offers in-store amenities, consisting of Target Caf', Target Photo, Target Optical, Portrait Studio, Starbucks and other food service offerings. A greater number of general merchandise stores provides an edited food assortment, including perishables, dry grocery, dairy & frozen items. Its digital channels include a wide merchandise assortment, including many items found in stores, along with a complementary assortment.

Of the 35 analysts covering Target, 10 have a Strong Buy, 3 have a Moderate Buy rating, 18 have a Hold rating, 1 as a Moderate Sell rating and 3 have a Strong Sell rating.

Conclusion

Selling a Target put option before their earnings announcement is a strategy that can potentially generate income while taking advantage of heightened volatility. However, it's essential to understand the risks involved, including the possibility of assignment and unlimited losses. 

Conservative investors may consider buying a further out-of-the-money put to reduce the risk and capital requirements.

This essentially turns the trade into a bull put spread.

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.