Monday, December 22, 2014

WAG: Volatility play

The pharmacy retail chain Walgreen Co. (WAG), headquartered in Deerfield, Illinois, publishes earnings prior to the opening bell on Tuesday, Dec. 23. Implied volatility is in the 7th decile, but it is embedded within a sideways trend that makes it less weighty than might otherwise be the case; [WAG in Wikipedia]


Implied volatility is in the 72rd percentile of the rise from 20% on Nov. 13 to 33% on Dec. 16. It is the second time volatility has tested the low 30s as it traces a sideways trend that began August 22.

Typically in this period of market history, volatility has traced a rise from August into November, followed by a short fall off. That pattern means that the rise to the peak carried volatility quite an impressive distance with true upside momentum..

Click on chart to enlarge.
WAG 6 months daily bars, with implied volatility
The WAG chart, by contrast, has had two truncated rises that fell well short of the major peak of the past six months: 43% on Aug. 1. The 72rd percentile in the range topping at 33% is calculated according to my normal way of analyzing such things, but it is overly high if I consider 43% to have been the true top.

It is a conflict of form over substance. Formally, 72nd percentile is correct. Substantially, maybe not.

 The one standard deviation range, encompassing 68.2% of trades, suggests a potential gain or loss of 5.1% in the 11 days until the options I'm considering expire. The two standard deviation range, covering 95% of trades, implies a 10.1% potential 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 low on the chart range was attained during a sideways corruption on Dec. 9, and the high was marked on Dec. 12. A move above that high would imply a resumption of the uptrend. A decline below the low end of the range would suggest continuation of the downtrend.

The Trade

It is impossible from this chart for me to decide a direction for the trade.

Click on chart to enlarge.
WAG 15 days 15-minute bars
The rise up to $74.82 on Dec. 18 brought the price nearly back to its  Dec. 12 peak, which could argue for a sideways correction, suggesting a further rise lies ahead, However, it could also simply be a strong counter-trend recovery that will be followed by a downward plunge.

There is simply no way to choose among the two directions.

At this point, I need go no further in my analysis.

Decision for My Account

The traditional solution when faced with a non-directional chart is an iron condor, which can profit whether the price goes up or down. However, I'm not a fan of that construction. Along with the possibility of bidirectional profit comes the chance for bidirectional lost. A vertical spread as a profit cliff in only one direction. An iron condor has a cliff on either side.

So instead I shall take the safest possible course: I'm passing on the trade and won't be opening a position today u WAG.

-- Tim Bovee, Portland, Oregon, Dec. 22, 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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