Tim Bovee, Private Trader: TIVO: Volatility play

Tuesday, November 25, 2014

TIVO: Volatility play

TiVo Inc. (TIVO), a San Jose, California developer and manufacturer of set-top boxes that allow for deferred viewing of TV content, publishes earnings after the closing bell today, Nov. 25. [TIVO in Wikipedia]

I'm considering it as a very short term trade under my Volatility Rules, but it runs afoul of a narrow distribution of open interest on its options grid.

Volatility

TIVO's implied volatility stands at 41%, compared to 13% for the S&P 500 index, and is in the 60th percentile of the 23-day rise that ended Nov. 14 at 45%. It has turned downward beginning on Nov. 20 and has fallen sharply and steadily in the days that ensued.

The one standard deviation range, which options pricing implies will encompass 68.2% of trades over the next week, carries a maximum gain or loss of 5.6%, and the two standard deviation range, encompassing 95% of trades, carries an 11.3% gain or loss.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	13.70	14.43	13.30
Lower	12.24	11.51	12.53

Implied volatility 1 and 2 standard deviations; chart support and resistance
The Trade

The chart shows TIVO's price near the top of a counter-trend move to the upside amid a downtrend that began in late August. From Nov. 3 onward it has formed a slightly descending triangle that I interpret as giving the chart a bearish bias, the sort of behavior traditional analysts call "topping".

Click on chart to enlarge.

TIVO 90 days 2-hour bars

The relatively high implied volatility and the downward bias suggest that the best trade structure would be a short vertical spread, sold for a credit. TIVO has no Weeklys in its options inventory, and so the best I can manage is a Dec. 19 expiration.

That's 25 days out, and I prefer 14 days or under. However, if I can structure a decent trade that is offset in a way that gives me reasonable upside protection with a decent risk/reward ratio, then I would be willing to absorb the extra time before payoff.

My goal is to protect all of the one standard deviation range. Given the distribution of open interest across TIVO's strike prices, the only choice to accomplish that is to go short the $13 calls. I need to go long the $14 calls to complete the a bear call spread. Since there is only single-digit open interest in strikes higher than $14, the best upside protection I can provide falls short the upper boundary of the one standard deviation range.

Probability of expiring out-of-the-money Bear call spread, short the $13 calls and long the $14 calls, sold for credit and expiring Dec. 19

DEC	Strike	%
Upper	13	53.11

That spread provides a risk reward ratio of 2.2:1, which is well within my preferences. However, that low risk comes at the cost of an unacceptability low probablilty that the short options will expire out of the money for maximum profit.

I prefer at least 70% probability, and the 53% probability of this position is far too low for my taste.

Decision for My Account

The distribution of open interest and therefore risk on the TIVO options grid makes it impossible to construct a position that meets my criteria, and I won't be taking this trade.

-- Tim Bovee, Portland, Oregon, Nov. 25, 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.