Tim Bovee, Private Trader: NKE: Volatility play

Thursday, December 18, 2014

NKE: Volatility play

Update 12/18/2014: NKE resumed a very near term uptrend late in the day, and I opened a bear position shortly before the closing bell, as described in the main analysis, below.

The price tested her $96.79 level several times but was unable to sore a persistent break above that level.

At the time of the trade, the price had produced a lower low and a lower high, but not yet a still lower low. That counts as a potential downtrend, but it takes the third mark to make it the real deal. This points out the quandary of all late-day trader: The clock is ticking, and there is no time for a measured decision.

Somestime in trading you've got to roll the hard six, and at this micro level, that is what I have attempted.

Click on chart to enlarge.

Nov. 18, 2014 pre-market to closing bell, 2-minute bars

After the trade, the price reversed and moved up to new heights, meaning that the dice turned against me in the final two minutes minute of trading. I'll find out tomorrow how well that correlates with the actual post-announcement price movements.

The sports-gear company Nike Inc. (NKE), headquartered in Beaverton, Oregon, publishes earnings after the closing bell today, Dec. 18. [NKE in Wikipedia]

High implied volatility, liquid options and the presence of weeklys in the options inventory make NKE a good candidate for trade keyed to a market response to the earnings announcement.

Volatility

Implied volatiity stands at 96%, which is in the 87th percentile of the rise that began Oct. 21 from 20% and peaked Dec. 16 at 31%. Volatility has declined a bit from that peak, anticipating its usual post-earnings decline.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	101.69	107.74	96.79
Lower	89.79	83.84	92.90

Implied volatility 1 and 2 standard deviations; chart support and resistance
I've calculated the standard deviation ranges based on the weeklys that I propose to trade. They are the JAN1 series, which expires Jan. 2.

The one standard deviation range, encompassing 68.2% of trades until expiration, suggests a potential 6.2% gain or loss, and the two standard deviations range, covering 95% of trades, suggests a 12.4% gain or loss.

The chart shows NKE in a decline from Nov. 28, the peak of a long-running rise. Since then the price has declined to a significant reversal to the upside on Dec. 17 that has retraced much of the final leg of the preceding decline.

Click on chart to enlarge.

NKE 15 days 15-minute bars

Today's trading early on hit a peak and fell. I judge NKE to be in a downtrend from that peak. A break above $96.79 will prove my opinion to be wrong, and a break below $92.90 will confirm the opinion.

The Trade

I shall construct the position as a bear call spread, using the JAN1 weeklys series.
.
Bear call spread, short the $99 calls and long the $101 calls sold for a credit and expiring Jan. 2 Probability of expiring out-of-the-money

JAN2	Strike	%
	99	70.81

The $99 strike leaves 2.2% of the one standard deviation range unprotected but protects all of the resistance-defined range on the chart,

The risk/reward ratio is 3.3:1.

Decision for My Account

The numbers argue for this trade. The one point of ambiguity, as always, is the trend. I shall wait until the half hour before the closing bell before a final decision on this trade. I'll take the trade if the price remains below $96.79. If it breaks above that level, then I won't make the trade.

-- Tim Bovee, Portland, Oregon, Dec. 18, 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.