Update 1/28/2015; NFLX and USB each moved sharply opposite the direction of my positions and I've exited for a loss.
NFLX shares rose by 33.8% over the eight day lifespan of the position, or a 1,542% annual rate. The options produced a -234.7% loss on debit, for a -10,707% annual rate.
USB Shares rose by 4.5% over the eight day lifespan of the position, or a 207% annual rate. The options produced a 225.0% loss on debit, for a 10,266% annual rate.
Update 1/27/2015: CREE moved sharply counter to my bear position after earnings were published, and the short leg of my options spread was assigned on Jan. 26, dumping short shares into my account. In exchange, I got to keep the credit I had received when I sold the options upon entering the position.
I closed out the shares on Jan. 27 for a loss, and also exited the long leg of the options spread for a profit.
The assignment in essence split the once unified spread into three components -- short options, long options and short shares -- so results calculations will all be averages of the three.
On the market, shares in CREE on rose 12.9% over the five days I held the positions or a +1,011.7% annual rate. The options spread and shares after assignment produced a -1.9% loss on debit, for a -151.0% annual rate.
Lessons Learned:
I positioned the trade as a bear play based on sound reading of the chart. The market saw it otherwise and moved against my position.
The downtrending trend channel (in red) showed a decline over the past month, and the Jan. 14 low was a lower low. At the time i opened the position, marked on the chart by a green line, the price was meandering sideways after a break above the the channel. Call it sideways, or maybe call it rising, since it had produced a higher high at a very low degree.
Click on chart to enlarge.
 |
| CREE 1 month 19 days, hourly bars |
Applying the new directional score standard retroactively to CREE, I get this result.
- A score of +1 if I count the one-day trend as neutral
- A score of +2 if I count that trend as rising.
In both examples, I counted the 30-day trend as declining. By contract, my analysis today for AAPL, about which analysts are wildly bullish, produced a score of 4. So by the AAPL standard, CREE was weakly bullish.
A score of 4 is the maximum possible, and -4 the minimum. So, on the bull side, 3 and 4 are above the median -- strongly bullish -- and 2 and 1 are below it -- weekly bullish. A score of zero means don't take the trade. A -3 or -4 are strongly bearish, and a -2 or -1 are weakly bearish.
A score of 4 is the maximum possible, and -4 the minimum. So, on the bull side, 3 and 4 are above the median -- strongly bullish -- and 2 and 1 are below it -- weekly bullish. A score of zero means don't take the trade. A -3 or -4 are strongly bearish, and a -2 or -1 are weakly bearish.
By that standard, I would have opened a bullish position in CREE, accepting a lower premium in exchange for greater hedging and a greater probability of a successful trade. As it turns out, I would have been on the profitable side of the trade.
This is one piece of information that backs my decision to bring analyst opinion into the mix when trading at this low a degree. Obviosuly, one datum point does not a trend make. I'll continue to keep track and shall post on it from time to time.
Three companies meeting my basic liquidity and price requirements publish earnings Tuesday after the closing bell.
They are
- the semiconductor company Cree Inc. (CREE), headquartered in Durham, North Carolina,
- the grandfather of information technology companies International Business Machines Corp. (IBM), headquartered in Armonk, New York,
- and the online television network Netflix Inc. (NFLX), headquartered in Los Gatos, California.
All four have Weeklys among their options inventories, and I shall trade the JAN5 series of options, which trades for the last time on Jan. 30, 10 days hence.
CREE
Volatility
Implied volatility stands at 61%, in percentile 88 of the rise from 38% on Nov. 26, 2014 to 64% on Jan. 15.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 34.21 | 37.34 | 32.64 |
| Lower | 27.97 | 24.84 | 29.21 |
| Gain/loss | 10.1% | 20.1% |
Click on chart to enlarge.
 |
| CREE at 9:50 a.m. New York time, 90 days 4-hour bars |
The stock price is in a clear downtrend, and I shall structure my trade as a bear call spread. Although the price rose in overnight trading, it has fallen since the opening bell, aligning with the broader trend.
The Trade
sold for a credit and expiring Jan. 31
Probability of expiring out-of-the-money
| JAN5 | Strike | % |
|---|---|---|
| 32.5 | 69.5 |
The risk/reward ratio stands at 5:2. The trade covers all of the chart range and all but 4.2% of the one standard deviation range, encompassing 68.2% of trades between now and expiration.
IBM
Volatility
Implied volatility stands at 29%, in percentile 93 of the rise from 15% on Nov. 14, 2014 to 30% on Jan. 15.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 164.32 | 171.94 | 159.97 |
| Lower | 149.10 | 141.498 | 153.80 |
| Gain/loss | 4.9% | 9.7% |
Click on chart to enlarge.
 |
| IBM at 10:20 a.m. New York time, 90 days 4-hour bars |
IBM as been in a downtrend since the spring of 2014, when it attained a peak just shy of $300. It has since declined sharply, much of the fall coming as a 9.8% decline in a single hour of pre-market trading after earnings were announced on Oct. 20, 2014. The report came in 14.5% below the street estimate.
Afterward prices tracked sideways, with one sharp dip that began to recover on the fourth day after it began. The price has since declined again from the sideways trend level, this time at a more measured pace.
Working up the magnitudes of analysis, from smaller to greater, IBM is in a downtrend within a sideways trend within a downtrend.
Although I generally ignore the market's storylines, they may be significant in this case. IBM knows it got a block eye in the October earnings report and will have been working overtime to ensure that it doesn't happen again in this report. The markets will be looking for a storyline that depicts as IBM as a someone elderly come-back kid -- perhaps "There's life in the old gal yet" will be the headline everyone wants to write.
The Oct. 20 Street estimate was earnings per share of $4.306. The actual was $3.68. This time the Street has set the estimate at $5.27, compared to the year-ago report of $6.13, giving a negative growth estimate: -11.8%.
So I'm seeing "downtrend" scrawled on the chart and in the Street estimates, and I intend to structure the trade as a bear call spread. However, given the nature human affinity for come-back stories, I'll be setting up the trade with the idea in mind that a surprise would be -- unsurprising.
The Trade
sold for a credit and expiring Jan. 31
Probability of expiring out-of-the-money
| JAN5 | Strike | % |
|---|---|---|
| 160 | 69.8 |
The risk/reward ratio stands at 13:5. The trade covers all of the chart range but leaves 2.2% of the one standard deviation range unprotected.
NFLX
Volatility
Implied volatility stands at 58%, in percentile 91 of the rise from 28% on Nov. 14, 2014 to 61% on Jan. 12.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 370.34 | 402.85 | 343.00 |
| Lower | 305.30 | 272.79 | 317.01 |
| Gain/loss | 9.6% | 19.3% |
Click on chart to enlarge.
 |
| NFLX at 10:35 a.m. New York time, 90 days 4-hour bars |
Rather than a sideways trend, NFLX retraced to the upside and the began a downtrend which hit a low in mid-December 2014, retraced a bit to the end of the month, and then resumed its downward course in January, bottoming on Jan. 12 and then bouncing back to the upside on Jan. 16, a movement I've marked with a yellow oval.
The rise, setting a higher high, makes the chart a bit problematic, making it an uptrend (higher high) within a downtrend stretching up into the higher degrees of analysis. Do I conclude that traders began setting up for earnings only a few trading days before the announcement, or do I figure that they began setting up in early January, several weeks before.
Head says, several weeks, meaning I'm bearish; Heart says, Foolish to trade counter-trend, even if the trend is of very small degree. If I listen to that latter voice, then I'm bullish or I don't take the trade.
Trading volume rose on Jan. 16, but did not exceed the level of trading earlier in the week where the price remained stable. By that measure, I must give credence to the rise, but not consider it to be a major reversal.
In the Oct. 15, 2014 earnings announcement that produced a 27% decline in an hour of post-market trading, NFLX came in 5.6% above the Street estimate, illustrating yet again the sheer quirkiness of the relationship between earnings estimates and trading results.
The Oct. 15 estimate was $0.909. The actual was $0.96. The current consensus for Tuesday's announcement is earnings per share of $0.44, compared to a year-ago actual of $0.79, producing a negative growth estimate: -44.2%.
Intraday price movements have been uninformative, to say the least. The price dropped sharply in the first 15 minutes after the opening bell, and then retraced that decline in part in the 50 minutes that followed.
The retracement has stopped short of the opening high and appears to be faltering. I shall go with a bear position.
The Trade
sold for a credit and expiring Jan. 31
Probability of expiring out-of-the-money
| JAN5 | Strike | % |
|---|---|---|
| 360 | 70.0 |
The risk/reward ratio stands at 17:10. The range of profitability covers all of the chart range and all but 2.4% of the one standard deviation range.
USB
Volatility
Implied volatility stands at 27%, in percentile 96 of the rise from 18% on Dec. 26, 2014 to 27% on Jan. 15.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 43.28 | 45.12 | 41.68 |
| Lower | 39.58 | 37.74 | 40.70 |
| Gain/loss | 4.5% | 8.9% |
Click on chart to enlarge.
 |
| USB at 10:55 a.m. New York time, 30 days hourly bars |
However, the rise does increase the risk of a bear trade. Just because it is of small magnitude doesn't mean that it will be so Wednesday morning as I survey the results of the earnings announcement.
All market movements, no matter how great or small the degree, are snapshots of trader psychology, which in turn is a manifestation of the Zeitgeist. Traders ignore them at their financial peril.
The one-day price rise was accompanied by declining volume, lower than the two prior days of price decline. That gives the reversal less credence.
The price declined sharply after the opening bell on Tuesday, confirming the downtrend and the need for a bear trade.
The Trade
sold for a credit and expiring Jan. 31
Probability of expiring out-of-the-money
| JAN5 | Strike | % |
|---|---|---|
| 41.50 | 61.1 |
The risk/reward ratio stands at 5:2. The position keeps all of the chart range in the zone of maximum profit at expiration but leaves 3.5% of the one standard deviation range outside of the zone.
Decision for My Account
I have opened positions in all four symbols -- CREE, IBM, NFLX and USB -- as described above.
-- Tim Bovee, Portland, Oregon, Jan. 20, 2015
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".
Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.
Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.
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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.License
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Based on a work at www.timbovee.com.
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