Tim Bovee, Private Trader: DHI, SLW, M: Volatility plays

Update 11/22/2014: The M options expired out-of-the-money for maximum (100%) yield on debit.

The shares gained 6.6% over the 11-day lifespan of the position, or 218.4% annualized, and the yield on debit was 3,318.2% annualized.

DHI and SLW were disposed of earlier.

Update 11/17/2014: I sold the shares dumped into my account by the options exercise. The stock price rose 1.54% over the four-day lifespan of both the options and the shares in my trade series. The two vehicles together produced a 0.3% yield on debit.

Update 11/15/2014: DHI rose for four days straight after earnings were announced and closed the day before expiration at $24.38, which is 1.6% above the $24 short calls that defined the upper range of profitability in my iron condor.

As a consequence, the $24 calls were assigned, and I am now the proud short-seller of several hundred shares of DHI stock, which I shall rid myself of immediately after the markets open on Monday.

I'll wait until I've bought back the shares before calculating profit and loss for the entire trade. But, sneak preview, the math will work like this:

I sold a stock worth $24.38 for $24, as the call contract obligated me to do, producing an instant loss of $38 per contract. This is offset by the $32 per contract premium I received when I sold the iron condor. So the net loss, on paper so far, is $6 per contract.

The actual calculation on Monday will substitute what I actually must pay for the shares in place of the $24.38 closing price of Friday.

The final results, of course, will be documented in an update here on Monday.

Side note: The close was within the one standard deviation, 68.2%, range of confidence, which was up to $24.89 within a week of the trade. The open interest distribution made it impossible to cover the entire range. Had I been able to do so, the trade would have been profitable.

Update 11/13/2014: My iron condor on SLW slid out of profitability on the upside today and I've closed the position for loss on the next-to-the-last trading day before expiration. During the three-day life of the position, the stock gained 5.8%. The options produced a loss on debit of 78.6%.

DHI, another iron condor, also became unprofitable on the upside. I was unable to get a fill on my close order so it will expire on Saturday with a loss

The Fort Worth, Texas, homebuilding company D.R. Horton Inc. (DHI) publishes earnings after the market closes today, Nov. 10. The markets are closed on Tuesday, so the impact of announcement on prices and volatility won't be known until Thursday.

The Vancouver, British Columbia silver miner Silver Wheaton Corp. (SLW) and the Cincinnati, Ohio department store chain Macy's Inc. (M) publish prior to the market's re-opening on Thursday.

They were selected from a field of 97 symbols announcing earnings prior to the market's re-opening.

I was able to choose from a wider field than is usually the case because the regular monthly November options expire on Nov. 21, 10 calendar days from now, brining them within the two-week window for very short term volatility trading.

Normally, I must pick from the much smaller field of options that have Weeklys among their options inventory.

(In Wikipedia: DHI, SLW, M.)

DHI

Volatility

Implied volatility stands at the 55th percentile of its prior rise and has fallen from a peak of 54% since Oct. 15. My interest wanes in the bottom half to the percentile range, so DHI still retains its savor, despite its flavorless level to the lower end of agreeableness.

Options are pricing n confidence that 68.2% of trades will fall between $22.21 and $24.89 over the next week, for a potential gain or loss of 5.7%, and between $22.94 and $24.16 over the next trading day.

The Trade

DHI has been engaged in a sideways correction since May 2013. The present upward leg began Oct. 20 and still has room to climb, although it could reverse at any time. The suggests a position structured so as to be direction-agnostic and sold for credit in the hope of profiting when the options expired with the stock trading within my range.

Sideways in the options world means an iron condor.

DHI has Weeklys that expire on after trading on Friday, but their range of acceptable open interest doesn't go out far enough to meet my needs, so I'm looking at the regular monthly options expiring in 10 days.

The price during the sideways correction this year has ranged from a bit above $19 to a bit above $25.

I note that Zacks Investment Research gives DHI a bearish rating, suggesting that if I have to skimp in one direction, it should be on the upward side.

At present, my draft trade is short the $24 and long the $25 call, and short the $20.5 long the $20 put. This gives me me a range of profit at expiration from $20.15 up to $24.29, covering most of the guidance range.

My choices were constrained somewhat by the distribution of open interest.

SLW

Volatility

Implied volatility stands at the 91st percentile of the previous rise, the highest level of the three symbols under consideration today.

Options are pricing in confidence that 68.2% of trades will fall between $16.93 and $19.63 over the net week, for a potential gain or loss of 7.4% over the next week, and between $17.66 and $18.90 po er the next day.

These numbers make SLW the most volatile of the three symbols.

Implied volatility has been falling from its peak of 55% since Nov. 4, although it has hooked upward in trading today.

The Trade

The chart is bearish but has been undergoing a upward revival for the past few days. Despite the strong bearish cast to the chart, I'm unwilling to commit to the bear play on the stock, which is rated neutral by Zacks.

So shall seek out an iron condor.

The chart gives little range guidance. SLW has Weeklys, and I'm looking to sell an iron condor built from those expiring at the end of this week. That gives four more days (including Tuesday; time-decay takes no holidays).

Implied volatility suggests $17 to $19.50.

I'm able to get close to that with my draft trade, which has a range of profitability from $17.32 to $19.18. Works for me.

The iron condor I'm putting into queue is short the $19 and long the $19.50 calls, and short the $17.50 and long the $178 puts. I'll sell it for a credit, with a maximum win coming if the stock closes in the range of profitability.

M

Volatility

Implied volatility stands at the 66th percentile of the rise that peaked Oct. 15 at $34%. Since then implied volatility has hooked downward and has been undulating sideways like a rattlesnake since Oct. 21, no doubt preparing to strike once earnings are published.

Options are pricing in confidence that 68.2% of trades will fall between $56.85 and $62.47 over the next week, for a potential gain or loss of 4.7%, and between $58.38 and $60.94 over the next day.

The Trade

On the chart, the price has been in a decline since peaking in early September and began stair-stepping upward in mid-October. My assessment of the chart places M in a counter-trend corruption within a downtrend.

I would be shocked if the price moved above the peak, $63.10, but I'm unable to put set a downward limit.

The Zacks rating for M is neutral, giving me no help at all in trying to assess a direction. Since there's no way of saying when the reversal will come, I'm most comfortable with a direction-androgynous trade, making this, The Day of Three Condors, of the iron variety.

M is a fairly high-priced stock, which means the option strike prices are spaced $2.50 apart. That influences my draft trade, forcing me to go wider than I would like, thereby reducing my potential profit.

My draft is a short iron condor, sold for a credit and expiring Nov. 21, which is 10 days from now. The structure is short the $65 and long the $67.50 calls, and short the $55 and long the $52.50 puts.

This produces a range of profitability at expiration running from $54.64 to $65.37, more than covering the guidance ranges.

Decisions for My Account

All three positions work for me. For these trades, so close to earnings, there's no need to wait. I have opened the positions as outlined above.

-- Tim Bovee, Portland, Oregon, Nov. 10, 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.