Wednesday, November 12, 2014

JCP, CSCO, WMT: Volatility plays

Update 11/22/2014: JCP and CSCO expired out-of-the-money for maximum (100%) yield on debit

JCP shares lost 4.4% over the nine-day life of the position, or -139.5% annualized, and the options yield was a positive 4,055.6% annualized.

The WMT position was closed prior to expiration.

Update 11/16/2014: My WMT trade entered the last week of its lifespan in the money, and I have exited the position.

The position was structured as direction neutral and could lose if the stock rose too far or fell too far. WMT rose too far, gapping up sharply after earnings were released and then rising for at least two days after that.

Altogether, the share price rose 5.5% over the five-day life of the position. The options produced a 475% loss on debit.

Update 11/12/2014: I've opened direction-neutral positions in JCP, CSCO and WMT as described in the analysis below.

I'm considering three symbols as potential very short term volatility plays coinciding with earnings announcements:
JCP and CSCO publish earnings after the closing bell on Wednesday, Nov. 12, and WMT announces prior to the opening bell on Thursday, Nov. 13. [JCP, CSCO, and WMT in Wikipedia]

The three symbols were screened from 45 companies publishing earnings during those time windows. As my sieves, I used average volume, implied volatility as a percentile of the previous rise, and the front-month at-the-money bid/ask spread on call options for the period I'm likely to trade.



Implied volatility stands at 84%, in the 69th percentile of the rise to the prior peak on Oct 15.  It has since fallen and then partially recovered, producing the hook characteristic of many charts of late. Today in early trading it dropped off a bit to the downside, a positive sign when constructing a short volatility play.

Options are pricing in confidence that 68.2% of trades will fall between $6.48 and $8.18 over the next week, and between $6.94 and $7.72 over the next day,

The Trade

JCP's price has been meandering sideways since February after a substantial decline, ranging roughly between $6.80 and $11.40. A sharp move beginning in July stretched out the range from the prior $8 to $10 span.

My take-away is that JCP has no strong directional trend on the chart although, with the most recent move, the bias is slightly to the downward side.

Overall, the neutral direction argues in favor of an iron condor, an options spread that is direction agnostic.

Looking at the options that expire Nov. 21, the regular month issue, I've drafted a spread with a zone of profitability at expiration of  $6.75 to $8.27, which closely matches the week range implied by options but is a subset of the chart-implied range.

The draft trade is short the $8 calls and long the $8.50 calls, and short the $7 puts and long the $6.50 puts. The credit from sale of the spread is on the small side, because JCP is a low priced stock, now going for $7.36 a share. This drives up fees because of the 75-cent per contract charge for options.

The risk/reward ratio of the draft trade is 1:1 -- a balanced reading.



Implied volatility stands at 26%, within the 62nd percentile up to the rise to the prior peak on Oct. 15. Volatility has since declined from the peak and has seen no significant recovery. Rather than showing the common hook, CSCO shows the slide, which I find to be a someone more convincing argument for further decline.

Options are pricing in confidence that 68.2% of trades will fall between $24.22 and $26.04 over the next week, for a potential gain or loss of 3.61%, and between $24.72 and $25.54 over the next week.

The Trade

CSCO's price has executed a zig-zag decline in three waves since July and then in a rise taken back all of the final, declining wave. The recovery wave can be interpreted as the beginning of a bullish recovery, or as the opening move of a sideways trend. There's no way to tell at this point.

The up trending recovery wave carried from roughly $22.89 to $25.20, and if the the move is sideways that opening gambit and serve as a tentative range.

An uptrend would be confirmed by the price moving above $26, which can serve as the  upward boundary of a tentative range.

When in doubt, go for a direction-agnostic trade. I'll try for an iron condor,.

My draft trade is short the $27 call and long the $27.50 call, and on the other end short the $24 put and long the $23.50 put, sold for a credit and expiring Nov. 21.

The risk/reward ratio is 3:1, and the range of profitability at expiration is $23.89 to $27.12, encompassing all of the options-implied ranges and most of the not-very-persuasive implied range on the chart.



Implied volatility stands at 18%, within the 57th percentile of the rise to the Oct. 16 peak. Volatility has since declined sharply form the peak before recovering slightly, producing the hook pattern. It has  returned to the downside this week.

Options are pricing in confidence that 68.2% of trades will fall between $77.07 and $80.97 over the next week, for a potential gain or loss of 2.5%, and between $78.13 and $79.91 over the next day.

The Trade

WMT's price has been in a sideways trend since April 2013, with prices swinging between $73 and $80. The most recent leg of the trend has carried the price up to $80, so the next move is likely to the downside.

However, it is a sideways trend. A direction-androgynous position is less risky than a bearish play that relies upon the current downward-pointing leg. The rewards of a directional play are greater, however. I'll work with both in trying to come up with a draft trade.

The draft bear trade is structured as a bear call spread, short the $80 call and long the $81 call, sold for a credit and expiring Nov. 21.

The best I can do for a bear play gives me a breakeven point of $80.28, which is 1.5% above the current price. The risk/reward ratio is 2.6:1.

WMT's price has risen more than 1.5% following the past four earnings announcements. From that, I conclude that I should move on to an iron condor, which provides a range of profitability.

The draft iron condor is short the $81 calls and long the $82.50 calls at one side, and short the $76 puts and long the $75 puts on the other.

The range of profitability is $75.78 to $81.22. The risk/reward ratio is 5.5:1.

The upside hedge for the iron condor is 2.8%, which is a big improvement, although certainly not enough to contain a large movement. The $81 calls have a 79.11% chance of expiring out of the money for a profitable trade in that direction.

Decisions for My Account

I like WMT the least out of these three choices because of the difficulty in creating a position. But there is no reason to reject any of them. I shall place all three trades and update this post after the orders are filled.
-- Tim Bovee, Portland, Oregon, Nov. 12, 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.

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. 

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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