Wednesday, October 15, 2014

EBAY: Volatility play

Update 10/16/2014: EBAY's implied volatility never hooked to the downside. Such a pattern is required by my trading rules, and so I won't be opening a very-short-term volatility play keyed to today's earnings announcement after the closing bell. The lack of a decline in volatility comes as know surprise. EBAY is publishing earnings at the end of a day of extreme swings in the S&P 500.

Anyhow, my trading rules are meant to be followed, so follow them I shall -- no trade, no roll forward, my flirtation with EBAY is history. It was fun while it lasted.

eBay Inc. (EBAY), the online auctions house headquartered in San Jose, California, publishes earnings after the closing bell today, Oct. 15. The implied volatility profile argues for a trade based on my very short term volatility rules. History, however, suggests an unpredictability in how the stock reacts to an earnings announcement. (eBay in Wikipedia).


Implied volatility stands at 35% has has been rising from its one-year low of 15% recorded on Aug. 7. It stands in the 83rd percentile of its one-year range and the 94th percentile of the decline from the most recent peak of 35% recorded April 11. However, implied volatility stands 6% below historical volatility, which is 36%.

Options hit a peak of just below 36% on Oct. 13 and have since hooked downward by 1.07 percentage points, a pattern I explicitly require for my volatility plays.

Options are pricing in confidence that 68.2% of trades will fall between $48.16 and $53.02 over the next week, for a potential gain or loss of 4.8%, and between $49.49 and $51.69 over the next day.


Earnings announcements have split evenly in their impact over year -- two were followed by falling prices, but two by rising prices. All resulted in declining implied volatility.

The rises came when earnings were announced at the one-year volatility high, the highest of the peaks, and at the smallest of the four historical peaks. The declines came at two peaks somewhere in between. The present price is near the one-year high.

EBAY's price has been on a long slide since its Sept. 30 peak, setting a series of lower highs interrupted only once during the descent.


The Street consensus expects 3rd quarter earnings to come in 4.7% above the year-ago quarter but 2.9% below the prior quarter.

EBAY has surprised to the downside only once in the past three years, back in 2013. All other quarters have produced upside surprises.


I would structure the position as a bear call options spread, using the weeklys, short the $52 calls and long the $53 calls, sold for a credit and expiring Oct. 31. I selected the further out expiration because of EBAY's inconsistent price reaction to earnings announcements. The longer lifespan gives me a bit more time to work with.

The position would have nearly 7:1 ratio with a $52.27 break-even point.

Decision for My Account

EBAY has its risks because of its inconsistent price response to earnings, but I think it's a risk worth taking. I intend to open a bear position in EBAY if current conditions persist into the half hour before the closing bell.

I'm hedging the risk by choosing an expiration 16 calendar days out rather than going for nine calendar days, by the fact that a vertical spread by its nature limits the loss, and by setting a stop/loss signal at the break-even price.

-- Tim Bovee, Portland, Oregon, Oct. 15, 2014


My volatility trading rules can be read here. For a discussion of the rationale behind the rules, see my essay, "Rules for very short term trades".

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

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