RH Call Traders Bank Big on Pre-Earnings Rally

Rising pre-earnings implied volatilities (IV) helped push this position over the top

Managing Editor
Sep 12, 2019 at 1:02 PM
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Subscribers to Schaeffer's Weekend Player options recommendation service just scored a 196% profit on RH Inc (NYSE:RH) November 150 calls. Below, we'll explain why we anticipated a surge in RH shares, and how the winning options trade unfolded.

At the time of our recommendation on Sunday, July 21, shares of the home furnishings retailer had surged following an impressive mid-June fiscal first-quarter earnings report. Plus, the directional signals issued by the 20-day Relative Momentum Index (RMI) -- an indicator that is heavily based in uptrends and downtrends over time -- had been quite reliable. We also noted the modest but steady rise in RH's 320-day moving average, which had proven to be a highly reliable line of demarcation for shifts in underlying price direction (and was serving as a source of strong price support).

The aforementioned technical factors painted a very bullish picture for RH shares. But there was plenty of bearish investor sentiment in evidence, further fueling our view for a contrarian rally over the intermediate term. For example, finviz.com data indicated that short interest in RH shares stood at an enormous 32.74% of share float, and that this accumulation of bearish bets would require more than five trading days to be fully covered at the stock's average daily trading volume.

And the analyst-based data at zacks.com informed us that of the 14 analysts who cover RH, just six rated the shares a "buy." In addition, the big rally by RH off the May lows had excited no one in particular in the options market, as the level of implied volatility for RH options (an indication of buying demand from option buyers) was lower than 99% of such readings over the past year (source: Trade-Alert).

Our recommended RH November 150-strike call option was set to reach its targeted profit of 200% on a rally by RH to just north of $165 over the recommended holding period. Following the entry of our call on Monday, July 22, as we predicted, the shares immediately jumped off the historically supportive 320-day moving average. This sent RH on a steady trend higher, aided by a guidance-related bull gap on July 30 -- and the short interest data released today confirms that quite a few bears were squeezed out by the stock's ensuing gains.

Ahead of the home furniture issue's earnings report this past Tuesday evening, we decided to close out half of our position on Monday, Sept. 9, for an average profit of 186% -- allowing us to lock in healthy gains on the position ahead of this event. However, a continued climb in RH's share price and pre-earnings implied volatilities (IV) helped push the remaining half of this position over the top to its target 200% profit just ahead of its earnings release.

On Tuesday, Sept. 10, we closed the final half of our November 150 call when the option traded as high as $17.00, yielding a 205% return. On balance, traders locked in a net profit of 196% on the full position in under three months -- a period of time during which RH shares rose just about 24%, by comparison.

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