Strategies for Deere & Co. (DE) before earnings

Deere & Co. DE recently abandoned a nice uptrend that had taken the shares to a new closing high on August 9. This uptrend, driven in part by strength in the overall agriculture sector as Russia experienced a drought, came to a screeching halt as the broader market spun on its heels.

Analysts with Citigroup, however, may feel that the pullback in DE is short-lived. On Monday, the firm upped its price target on the stock to $75 from $70. The firm expects “better [North American] large ag equipment demand, and a more favorable price/cost spread driving upside to near term numbers.” The price adjustment, which allows for roughly 15% upside in the shares, comes just days before Deere earnings scheduled for the morning of August 18. Analysts are expecting results of $1.22 per share.

With earnings around the corner, volatility is elevated; the front-month, at-the-money DE straddle (August 65) is currently priced at $3.17, or roughly 4.8% of strike. In other words, the options market thinks DE is likely to move almost 5% (higher or lower) between now and the expiration of August options this Friday.

We’ve outlined two potential option strategies here – first a calendar spread for those wanting to express a bullish thesis but concerned by elevated premiums just prior to earnings. Second is a bear call spread, which is a credit spread and can actually benefit from falling implied vols.

Remember these are not buy/sell/hold recommendations, merely examples of various strategies for educational purposes. The prices are taken as of Monday afternoon, when DE shares were trading at $65.60, up 75 cents on the day.

Bullish Option Strategy: Calendar Spread

Investors who feel earnings may be moderately positive for the shares could trade an August/September 70-strike call calendar spread. Effectively, shorting the front-month option helps lower the debit for the September call. Investors can currently trade this spread for a net debit of roughly 89 cents.

On Friday, when August options expire, this spread theoretically will be in positive territory if DE is trading between $65.48 and $75.15. Gains peak right at the 70 strike, as the August options expires worthless (allowing the investor to keep 100% of the credit from the sale) but the September option has time remaining to participate in future upside.

After August expiration, if the stock is below 70 dollars, the trader is left with the September 70 long call. Losses are limited to the entire premium paid (89 cents) and occur if DE is trading below $70 at September expiration. Gains, however, are potentially unlimited if the stock rallies. Breakeven for the long call after expiration is $70.89. If the stock is above $70.00, the short August call will be assigned, creating a short stock position. Short stock, long September 70 strike call is the synthetic equivalent to a long put, and will have the same risk characteristics. The management of a calendar at the first expiration date is critical to provide the exposure the trader desires. In most cases, the short August option would be covered and bought before expiration, leaving the trade long the September call.

Deere (DE) calendar spread

Bearish Option Strategy: Bear Call Spread

Investors on the bearish side of the fence might be turned off by put premiums. One way to trade Deere bearishly but collect a credit up front is by shorting a bear call spread. By selling the December 67.50/72.50 call spread (selling the 67.50 strike, buying the 72.50 strike), the investor collects a net credit of roughly $1.90. He can keep this entire credit at expiration if DE is trading below the short strike ($67.50). Because both calls are out-of-the-money currently, the shares do not need to move lower for this spread to succeed; they need only to not move higher.

While this credit is the maximum potential profit, the maximum potential loss is $3.10, or the width of the spread minus the premium collected. This loss occurs at expiration if DE is above $72.50. The investor breaks even on this spread at $69.40. So if DE is trading anywhere below this level when December options expire, the spread is profitable.

Deere (DE) bear call spread