Tuesday, December 2, 2014

ANF: Volatility play

Update 12/9/2014: ANF rose sharply today and I've closed out my bear position, which was due to expire on Saturday, and was charged a debit that still left the position profitable.

The shares declined by 3.2% over the seven-day lifespan of the position, at a 164.1% annual rate. My options spreads produced an 80% yield on debit, for a 4,171.4% annual rate.

Update 12/2/2014: I've opened a bear position on ANF, as described in "The Trade" section below

Abercrombie & Fitch Co. (ANF), a clothing retailer aimed at younger people operating 1,000 stores globally, publishes earnings on Wednesday, Dec. 3, prior to the opening bell. The company is headquartered in New Albany, Ohio. [ANF in Wikipedia].


Standing at 58%, compared to 14% for the S&P 500, ANF's implied volatility is in the 85th percentile of its rise that peaked on Oct. 13 at 58%.

The one standard deviation range, anticipated to encompass 68.2% of trades, implies a potential maximum gain or loss of 8.1% over the next week, and the two standard deviation range, encompassing 95% of trades, implies a 16.2% gain or loss.

Ranges implied by options and the chart
WeekSD1 68.2%SD2 95%Chart
Implied volatility 1 and 2 standard deviations; chart support and resistance

The chart is bearish, having dropped sharply from $35.50 beginning Nov. 6 as part of a larger down trend that began Aug 27 from $45.50. The lower boundary of the range is the low from Monday's trading, and the high is the peak of a largely sideways pause from Nov. 10 to Nov. 25 that interrupted the decline.

Click on chart to enlarge.
ANF 20 days 30-minute bars

The Trade

Based on the chart, I shall attempt to construct a bear call options spread. ANF has Weeklys in its options inventory, and so I shall aim for the DEC2 series expiring Dec. 13, with final trading on Dec. 12.

I can go with a further out of the money spread, $1 wide, providing protection up to $31 plus the premium, but only at the cost of  4.3:1 risk/reward ratio. In return, I get a 78% confidence that the position will expire out of the money for maximum profit.

Or can go less deep with protection up to $30 plus the premium, with a 3.2:1 risk/reward ratio and 70% confidence that the position will expire out of the money. The premium prior to the opening  bell is 24 cents per share, so I'm actually only giving up 19 cents of protection of the one-standard deviation range, in exchange for a full point lessening of risk.

A no brainer, really. I'll go with the latter, with the 3.2:1 risk/reward ratio.
Bear call spread, short the $30 calls and long the $31 calls, sold for a credit
Expires Dec. 13, 2014
Probability of expiring out-of-the-money

Decision for My Account

Clarity on the chart and a wide choice on the options grid. I like this trade and shall open a position today.

-- Tim Bovee, Portland, Oregon, Dec. 2, 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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All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.

Based on a work at www.timbovee.com.

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