Shares declined by -0.5% over the eight-day lifespan of the position, for a -21.1% annual rate. The options produced a +100% yield on debit, or a +4,562.5% annual rate.
Update 1/23/2015: MS slipped into the money on the last day of trading for the JAN4 Weeklys options series, creating the risk that it would be exercised upon expiration. I exited the position 2-1/2 hours prior to the closing bell.
Shares rose by +1.2% over the seven-day lifespan of the bear position, for an annual rate of +122.6%. The options produced a +77.8% yield on debit, or a +4,055.6% annual rate.
Update 1/22/2015: DAL gapped sharply to the upside after earnings were announced, putting my bear trade on the wrong side of the market. The share price at which I exited was within the two standard deviation range implied by volatility, encompassing 95% of trades, but above one standard deviation range, encompassing 68.2% of trades.
Shares rose by 11.2% over the six-day lifespan of the position, for an annual rate of 682%. The options spreads produced a -225.8% loss on debit, for an annual rate of -13.737% annualized.
Volatility plays timed to coincide with earnings are very much like playing the lottery -- You buy your ticket and cross your fingers, because if the outcome moves against you, there's little to nothing that can be done to mitigate the loss.
The cause of the loss is obvious. I picked the wrong direction for the trade. In my analysis, below, I had noted an upside reversal to the larger downtrend. This occurred within a marked longer-term downtrend.
My premise has been that the 30 days before an earnings announcement is when traders get their positions established in the way that they think will best profit from the market response after earnings day. I've figured that the very near term trading, just prior to the announcement, is most likely speculators rather than traders looking more deeply at the company's business and finances.
My premise was certainly wrong in the case of DAL, and has been right in other instances. One other chunk of knowledge I can bring into the is analyst ratings. In the of DAL, for example, Zacks Investment Research had rated the company "strong buy". The broker's enthusiasm index, something I construct for trades under my shorter-term rules, which generally last a few months, was 63% for DAL, quite a high level.
My take-away from this "lessons learned" discussion is that my radical reliance on the chart is wrong especially in cases where there is a discrepancy between near-term and longer-term trends. Another take-away is that I should bring analyst opinion into the mix in analyzing volatility plays.
I'll need to figure out how precisely to do this -- perhaps just a weighted score for each? -- and shall implement it immediately as we continue to work our way through earnings season.
Update 1/16/2015: With an hour to go before the closing bell, HAL remains well above its opening price. This sets up a discrepancy between the longer term trend and the trend today. I am passing on the trade.
Click on chart to enlarge.
 |
| HAL at 3:05 p.m. New York time, 2 days 5-minute bars |
The airline Delta Air Lines Inc. (DAL), of Atlanta, Georgia; the Houston, Texas oilfield service provider Halliburton Co. (HAL); the oldline retailer Johnson & Johnson (JNJ), headquartered in New Brunswick, New Jersey; and Morgan Stanley (MS), a financial services company headquartered in New York City, all publish earning after the closing bell on Tuesday, Jan. 20. [DAL, HAL, JNJ, MS in Wikipedia]
All four have Weekly in their options inventories, and I shall be working with the JAN4 series, which trades for the last time on Jan. 23, seven days hence.
DAL
Volatility
DAL's implied volatility stands at 45.1%. in the 99th percentile of the rise from 33% on Nov. 24, 2014 to 45.2%. It's a perfect up for my purposes: A peak just before earnings and a slight decline prior to the announcement.
The one standard deviation range surrounding current volatility, encompassing 68.2% of trades, suggests a potential gain or loss of 6.3%, and the two standard deviation range, covering 95% of trades, a gain or loss of 12.5%.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 48.30 | 51.14 | 45.76 |
| Lower | 40.72 | 39.78 | 45.47 |
The Dec. 31 peak ended a rise of long duration and set off a sharp decline. Note that trading so far today has reversed the decline with an intra-day rise. (In the yellow oval to the extreme right of the chart.)
The chart range, based on the Jan. 15 high, is extremely narrow compared to the one standard deviation range. I could bring to two into greater conformity by using the Jan. 13 high of $47.75. However, the narrower $45.76 level is also a very real point of resistance, and a price move above that level would cast doubt on the very near term bearish case.
Of the longer-term trend there is no doubt: It is a downtrend.
Click on chart to enlarge.
 |
| DAL at 9:55 a.m. New York time, 30 days hourly bars |
The Trade
The DAL options grid is quite liquid and allows full discretion in setting up a position.
| JAN4 | Strike | % |
|---|---|---|
| 46 | 63.3 |
The proposed trade has a risk/reward ratio of 2:1. I've chosen to protect less of the one standard deviation range while protecting all of the price range, since pricing beyond the upper boundary of the chart range would mean that I got the trend wrong.
HAL
Volatility
HAL's volatility stands at 48%, in the 66th percentile of the rise of 34% on Nov. 24, 2014 to a high of 55% on Dec. 16.
The one standard deviation range, encompassing 68.2% of trades, implies a potential gain or loss of 6.6%, and the two standard deviation range, covering 95% of trades, a gain or loss of 13.2%.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 40.72 | 43.24 | 40.51 |
| Lower | 35.68 | 33.16 | 37.04 |
An alternate high in the chart range would bring the upper boundary to $41.10, but I've chosen the lower level as marking a true, and the nearest, reversal point.
The peak of July 23 ended a long uptrend. HAL has since been in a clear downtrend, although showing a sideways pause for the past month and a very-near-term downtrend for the past week, which has reversed this morning into a sharp rise.
Click on chart to enlarge.
 |
| HAL at 10:20 a.m. New York time, 180 days 4-hour bars |
The Trade
The proposed trade covers most of both the chart range and the one standard deviation range.
| JAN4 | Strike | % |
|---|---|---|
| 40 | 71.8 |
The risk/reward ratio is 35:10.
JNJ
Volatility
JNJ's implied volatility stands at 22%, at the peak of its rise from 13% on Nov. 26, 2014.
The one standard deviation range, encompassing 68.2% of trades, implies a potential gain or loss of 3.0%, and the two standard deviation range, covering 95% of trades, a gain or loss of 5.9%.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 106.10 | 109.14 | 105.76 |
| Lower | 100.02 | 96.98 | 101.94 |
JNJ has been a troubled company for some time. From a very deep low in October 2014, JNJ rose in three weeks to a peak on Nov. 6, from which it has declined and continues to do so.
Although the trend is definitely down, the Street chatter of late has been all about JNJ's comeback. However, that's not the tale of the tape (an old saying dating back to the days when stock prices were reported on ticker tape).
I shall go with the tale of the tape rather than the wagging tongues of the Street and construct a bear play, while being cognizant of the discrepancy between storylines could pose a risk.
Click on chart to enlarge.
 |
| JNJ at 10:35 a.m. New York time, 90 days 4-hour bars |
The Trade
| JAN4 | Strike | % |
|---|---|---|
| 104 | 69.2 |
The risk/reward ratio on this trade is 14:5.
MS
Volatility
The MS implied volatility stands at 35%, in the 94th percentile of the rise from 34% on Nov. 13, 2014 to 48% on Jan. 15.
The one standard deviation range, encompassing 68.2% of trades, suggests a potential gain or loss of 4.9%, and the two standard deviation range of 9.7%.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 36.08 | 37.75 | 34.56 |
| Lower | 32.74 | 31.07 | 33.93 |
I've chosen the lower upside resistance -- today's high so far of $34.56 -- for the upper boundary of the chart range. A slightly more significant resistance level is the Jan. 14 peak of $35.30.
Click on chart to enlarge.
 |
| MS at 11 a.m. New York time, 30 days hourly bars |
The Trade
| JAN4 | Strike | % |
|---|---|---|
| 35.5 | 67.2 |
The proposed trade as an 11:5 risk/reward ratio. It covers all of the chart range but leaves 31 cents of the one standard deviation range out of the zone of maximum profit.
Decision for My Account
I've opened positions on DAL, JNJ and MS structured as described above. I'm waiting on HAL, which remains in an intraday uptrend, contrary to broader trend. I'll post an update on HAL later in the day, when I have more data to assess the best course.
-- Tim Bovee, Portland, Oregon, Jan. 16, 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
All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.
Based on a work at www.timbovee.com.
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