Tim Bovee, Private Trader: ORCL: Volatility play

Wednesday, December 17, 2014

ORCL: Volatility play

Update 12/17/2014: ORCL zig-zagged upward until 2:15 p.m. New York time and then began to zig-zag downward. It ended the day with a net rise over the prior day's close.

In terms of my proposed trade, I declined to switch to a bull position because that would run counter to Zacks, which bases its work on earnings forecasts and so deserves to be given great weight.

I declined to continue with a bear position because there is no clear very near term downtrend.

So, no trade.

The enterprise software company Oracle Corp. (ORCL), headquartered in Redwood City, California and best known for its data managing tools, publishes earnings after the closing bell today, Dec. 17. [ORCL in Wikipedia]

Volatility

Implied volatility stands at 33%, the peak of the rise from 20% that began Nov. 7.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	44.87	48.74	42.51
Lower	37.13	33.26	35.82

Implied volatility 1 and 2 standard deviations; chart support and resistance
The one standard deviation range implied by options volatility, encompassing 68.2% of trades over the 16 days until Jan. 2, when the JAN1-series weeklys expire, suggests a 9.4% potential gain or loss. The two standard deviation range, covering 95% of trades, suggests an 18.9% gain or loss of the period.

The chart range runs from the $42.51 peak attained Nov. 28 down to the low prior to the peak, attained on Oct. 20.

Click on chart to enlarge.

ORCL 1 year daily bars (left), 15 days 10-minute bars (right)

The chart has been trending downward since Nov. 28 in a series of zig-zags. That accords with the negative rating from Zacks Investment Research, the ratings service I use to short cut my fundamental analysis.

The Trade

Assuming a bear trade, I will structure the position as a vertical options spread sold for a credit. This gives me a very short lifespan for the position, which is precisely what I'm looking for, in part because it will benefit from the collapse of implied volatility that follows an earnings announcement.

Bear calls spread, shortt the $42.50 calls and long the $43.50 calls sold for a credit and expiring Jan. 2 Probability of expiring out-of-the-money

JAN1	Strike	%
	42.50	73.95

The best I can do to get the best hedge possible while producing a risk/reward ratio of better than 4:1 is to make the short leg the $42.50 strike in a position $1 wide. This produces a 3.8:1 risk/reward ratio, but a 74% probability that the position will expire in the money for maximum profit.

This leaves 4.8% of the one standard deviation range unhedged, and 12.4% of the two standard deviation range. However, it hedges all of the chart range, a significant benefit.

Decision for My Account

The most recent movement this morning is higher than the prior day's close although off from the peak so far today attained five minutes after the opening bell. That set off a series of movements that all remained above Tuesday's closing price.

Click on chart to enlarge.

ORCL 2 days 5-minute bars, at 10:15 a.m. New York time

There is no way I can assess a direction on this chart. In a posting on Monday, "Failed Trades: Lessons learned", I discussed the role that direction picking plays in trades of this sort, and why direction is of overwhelming importance.

In light of the chart of of that particular lesson learned, I'm deferring a trade until there intra-day trend gains some clarity. If it fails to do that, then I won't take the trade.

in either case, I'll update this analysis with the outcome.

-- Tim Bovee, Portland, Oregon, Dec. 17, 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.