Tim Bovee, Private Trader: BBY: Volatility play

Update 12/2/2014: My bull play on BBY's earnings announcement expired out-of-the money for maximum profit.

Shares rose by 3.5% over the nine-day lifespan of the position, or 140.8% annualized.

My options position, structured as a bull put spread sold for a credit, expired worthless, meaning I got to keep all of my premium. That amounts to a 100% yield on debit, or 4,055.6 annualized.

Best Buy Co. Inc. (BBY), the giant electronics store chain based in Richfield, Minnesota, publishes earnings on Thursday, Nov. 20, prior to the opening bell, and I'm considering it for a very short term trade under my volatility trading rules. [BBY in Wikipedia]

With the winter holiday shopping season upon us, much of the price action in BBY will hinge on how trader's assess its prospects in the maelstrom of the Black Thursday sales. The earnings announcement will be the trigger to act on those assessments, which ought to make for a very interesting trading day on the symbol.

But the devil, as always, lies in the details, so let us give the devil his due.

Volatility

BBY's implied volatility stands at 53%, compared to 14% for the S&P 500 index, and stands in the 63rd percentile of the rise to its most recent high, 66% on Oct. 27.

The trading range over the next week implied options pricing produces a potential 15.3% gain or loss at the 1st standard deviation, encompassing 68.2% of trades, and a 30.5% gain or loss at the 2nd deviation, encompassing 95% of trades.

This is wider than usual and points, in my mind, at least, to a degree of irrational exuberance on the part of traders that might well make Thursday a very interesting day for this symbol.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	$41.60	$47.10	$44.66
Lower	$30.58	$25.08	$22.15

Implied volatility 1 and 2 standard deviations; chart support and resistance
Click on chart to enlarge.

BBY 1 year daily bars

The Trade

The chart is clearly in an uptrend and has been most of 2014, although it is a countertrend rise within a downtrend that began in November 2013.

The trend has enough definition that I'm willing to go with bullish directional trade, structured as a bull put spread. I'll want to provide some protection to the downside, but with this chart, I feel less of a need to do so. It helps in the decision that Zacks Investment Research, the service I use as a short-cut in assessing the fundamentals and Street opinion, gives BBY a strongly bullish rating.

BBY has Weeklys in its options inventory. I'm looking at the options expiring Nov. 29, with open interest running malignly in the three- and two-figure range. My rules require triple digits at a minimum for trading, which will constrain my choice of strike prices. However, the strikes are spaced 50 cents apart, which increases my ability to fine-tune a trade.

The Nov. 29 expiration gives me 10 days after earnings are published -- long enough for the price to react and settle and short enough to give me high time decay, which increases my potential for profit.

I considered going out a week to the first Weeklys in December but found the open interest was insufficient.

The pattern of open interest on individual strike prices and the probability of expiring out-of-the-money, for maximum profit, guided my structuring of the trade.

The lower the strike price, the greater my downside protection. The lowest strike with triple-digit open interest is the $34 put. Below that is a gap of double-digit strikes down to $32, which is an isolated triple-digit.

That would give me $2-wide spread with a 4:1 risk/reward ratio and a 67.6% probability of expiring out of the money.

The lower boundary of the 1st standard deviation range, encompassing 68.2% of trades over the next week, lies 10% below the $34 strike, so 31% f the SD1 range is unprotected.

Probability of expiring out-of-the-money Short the $34 puts and long the $32 puts, sold for a credit and expiring Nov. 29

NOV4	Strike	%
Lower	34	67.24

Decision for My Account

Good risk/reward ratio, good directional bias, high probability of expiring out of the money -- there's nothing to dislike about this trade, and I've opened a bull put spread on BBY, as described above.

-- Tim Bovee, Portland, Oregon, Nov. 19, 2014

References

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.

My method of scoring price and volatility responses to earnings, used in the "Chart" section, is the simplest imaginable. Looking at the four most recent earnings announcements, I give one point for a rising price or rising volatility in the week after the announcement, subtract a point to a falling price or volatility, and give a zero if the response is sideways movement. I then add the four quarters together to produce separate scores for price and volatility, and then add the two to produce a combined score.

Disclaimer

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.