Key level to watch as stock mounts comeback

Home Depot shares could be building toward a breakout.

That’s TradingAnalysis.com founder Todd Gordon’s latest call on the home improvement retailer’s stock, which has lost steam in the month after its most recent earnings report as shareholders worried about margin pressures, tied in part to the company’s $11 billion “One Home Depot” project meant to overhaul its online and in-store shopping experiences.

Even though Home Depot’s stock has fallen nearly 8% since it released its fiscal third-quarter results, its declines should be used to investors’ advantage, Gordon said Tuesday on CNBC’s “Trading Nation.”

The “One Home Depot” plan “should increase and make operations more efficient going forward,” Gordon said. “So, I do like the pullback here. I think it’s a short-term blip in an otherwise very strong uptrend.”

In addition to buying shares of Home Depot on its recent pullback, Gordon also liked the idea of using the options market to boost his potential gains.

“You can see that we obviously have a very, very strong uptrend here in Home Depot,” Gordon said, citing the chart. “Even in 2019, we could identify a pullback towards uptrend support here if we connect these lows.”

Having confirmed several floors of support including its 200-day moving average, displayed in red in the chart above, Home Depot’s action in recent weeks suggests the stock will at least stay above a key level, the trader said.

“You have a lot of support down into the 210 area, and as we zoom in even further, you can see that Home Depot has kind of dropped down into that [level] … several times to break through support,” Gordon said. “Buyers have stepped in, defended that level, and we’re starting to push higher.”

Home Depot opened above the $218 level on Wednesday after overcoming that area of resistance in Tuesday’s trading session.

But Gordon was anticipating a push even higher for the stock, possibly back to its early November highs.

“We have another resistance [level] to contend with around 224. I think that’s all quite doable, and … the prize that we might be targeting would be this gap close from that November earnings all the way up around the old highs around 240,” he said. “I don’t know if we’ll get that full push, but it certainly looks like we could at least break through this resistance and potentially move into the 230 mark.”

The way Gordon chose to capitalize on that prediction — which could mean new all-time highs for the stock — was by buying call options, or making a bullish bet, on Home Depot’s trajectory through the end of March.

“The option trade that I have ready for you guys will likely benefit even if we move up to that 230 mark,” Gordon said. “[I’m] going out into the March monthlys, we’re going to be buying the 225 call strike [and] selling the 235 call strike, which, again, would correspond to that gap close.”

That represents a bet that Home Depot will rise between about 3% and 7% by the end of March and, at the time of the trade, cost Gordon roughly $3.31, or $331 per spread, to execute.

“That’s all you can risk on this particular trade. Now, the way we like to position-size is that we generally try to risk about half of what we pay in terms of the debit. So, 330 cut in half roughly becomes $1.65 or $165 per option spread that you have at risk,” he said, adding that investors must “be sure to position-size such that you are in line with your risk tolerance.”

The trader’s one caveat was tied to the retailer’s next earnings report.

“We do have earnings coming up at the end of February, so we’ll decide if we want to carry this trade through earnings depending on how this overall trade is developing, but for now, we’re ready to go,” Gordon said.

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