The broader market has staged an impressive recovery following last week's growth scare triggered in part by the Japanese central bank's decision to raise rates on the other side of the globe. Amid this broad comeback, Domino's Pizza (DPZ) , which had tumbled 18% after posting mixed earnings on July 19th, has seen a modest rise along with most other stocks. However, DPZ is encountering resistance around the $448 level, suggesting that its recent upward momentum may be fading.
A look at the 9-month daily chart reveals that the RSI, a key indicator of price momentum, has turned downward. This signals that the upward movement DPZ experienced over the past three weeks might be stalling, potentially turning into a "dead cat bounce." Given the bearish outlook, I'm utilizing a bear call Spread, also known as a call credit spread.
The strategy involves selling a $455 call option, positioned just above the resistance DPZ is encountering around the $445 level. To protect against potential upside risk and to define the trade's risk parameters, I'm purchasing a $460 call option. The trade Analyzing the DPZ options chain reveals that the probability of the stock remaining below $455 at expiration is nearly 80%, offering a high likelihood of success for this trade.
The trade generates a premium of $145, while the potential loss is limited to $355. Provided DPZ stays below $455 by the expiration date, this trade delivers a 40% ROI on the capital at risk. Here is my exact trade setup: Sold $455 call, Sep 20th expiry Buy $460 call, Sep 20th expiry Credit: $145 Credit spread trades like this one offer a high probability of success, with an expectation that approximately 7 out of 10 trades will be profitable.
However, this strategy comes with a caveat: while the winning trades generally yield modest profits that accumulate over time, the losing trades can result in more significant losses. In practice, the potential losses from the 3 losing trades could negate the gains from the 7 winners. This makes it essential to implement a robust risk management strategy.
By setting predefined levels to cut losses, you can prevent them from becoming too substantial. With disciplined risk management, credit spreads can deliver consistent returns over time. -Nishant Pant Founder: https://tradingextremes.
com Author: Mean Reversion Trading using Options and Technical Analysis Youtube, Twitter: @TheMeanTrader DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET.
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