Thursday, January 8, 2015

BBBY: Volatility play

Update Jan. 12, 2015: BBBY moved opposite the direction of my trade after earnings were published, gapping to the downside by 5.4%

The low the first trading day after the announcement was $72.38, which is 3.2% below the lower boundary of the one standard deviation range. 

The chance of expiring in the money for maximum profit was 20.45% at the time I closed the position.

I would have considered hanging on had the price begun trending up again. However, prices today, the second trading day post-earnings, are in the process of creating an inside day -- essentially a sideways triangle.

The shares declined by 7.4% over the four-day lifespan of the position, or an annual rate of -875.0%. My options positions, which were leveraged, of course, produced a -316.7% loss on debit, or -28,895.8% annual rate.

There was nothing in the chart that pointed to a sudden reversal. Even volume had been rising along with the price prior to the announcement. Earnings came in at $1.23 per share, which is above the  $1.193 consensus estimate. News reports blamed the decline on revenues that were lower than expected.

I count this as a true earnings surprise and see no "lessons learned" changes that need to be made.

The household goods retail chain Bed Bath & Beyond (BBBY), headquartered in Union, New Jersey, publishes earnings Thursday after the closing bell. The chart is bullish. [BBBY in Wikipedia]


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

Implied volatility stands at 36%, in the 96th percentile of the rise to the most recent peak on Jan. 6.

The one standard deviation range, encompassing 68.2% of trades between now and the January options expiration, provides a maximum potential gain or loss of 5.3%, and the two standard deviation range, covering 95% of trades, a gain or loss of 10.6%

Click on chart to enlarge.
BBBY 180 dys 4-hour bars
BBBY has been galloping to the upside since June 2014 with only relatively small downside retracements along the track.

The Trade

Bull put spread, short the $75 call and long the $74 call
sold for a credit and expiring Jan. 15
Probability of expiring out-of-the-money

The proposed trade covers all but 75 cents of the one standard deviation range and all of the range down to resistance.

The risk/reward ratio is 4:1.

Decision for My Account

I've opened a position in BBBY as described above.

-- Tim Bovee, Portland, Oregon, Jan. 8, 2015


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.


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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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