Thursday, January 15, 2015

INTC, SLB: Volatility plays

Update 1/24/2015 and 1/31/2015: INTC and SLB both expired out of the money for maximum profit. My Jan. 24 update and the original analysis had erroneously said that I traded the JAN4 series for SLB. It was the JAN5 series. While INTC expired Jan. 24, SLB expired Jan. 31.

INTC shares gained +0.5% over the nine-day lifespan of the bear position, for a +18.67  annual rate. The options produced a +100% yield on debit, or an annual rate of +4,055.6%.

SLB shares gained +6.0% over the 15-day lifespan of the bear position, for a +137.8%  annual rate. The options produced a +100% yield on debit, or an annual rate of +2,281.3%.

Both trades are fine examples of the hedging benefits provided by options spreads. Although in both cases, the share price moved opposite the direction of my trades, the offset in my break-even point in each case provided a zone of profit above the short-option strike price.

The semiconductor giant Intel Corp. (INTC), headquartered in Santa Clara, California, and the supplier of technology for oil and gas exploration and production, Schlumberger N.V. (SLB), headquartered in Houston, Texas, publish earnings after the closing bell on Thursday, Jan. 15. [INTC, SLB in Wikipedia]

Both have Weeklys in their options inventories, and I shall be working with the JAN4 series, whose final day of trading is on Jan. 23, eight days hence.



INTC's implied volatility stands at 32%, in the 81st percentile of the rise from 22% on Nov. 25 to 35% on Dec. 16.

The one standard deviation range surrounding volatility, encompassing 68.2% of trades, implies a potential gain or loss of 4.7% over the next eight days, and the two standard deviation range, covering 95% of trades, a potential gain or loss of 9.5%.

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 chart shows INTC trading out a decline since Dec. 5, 2014, with the peaks of Dec. 24, 2014 and Jan. 13, 2015 reversing at lower highs, the classic definition of a downtrend.

The broader context is bullish in the form of a rise following a major correction that ended in December 2012.

The Zacks Investment Service rating is bullish, matching the longer-term trend. However, that trend peaked on Dec. 5, 2014.

For a trade of this short a duration, I'll give greater weight to the near-term downtrend, especially given the bearish cast of the general market. (See "Thursday's Prospects" for a count of bull signals vs. bear signals on Wednesday among the 1,197 symbols I'm tracking this week.)

Click on chart to enlarge.
INTC at 9:55 a.m. New York time, 7 months 4-hour bars
The Trade

The lower high on the chart range is my main concern. I want to protect as much of that as I can, without much concern over the additional unprotected portion of the one standard deviation range, which has a higher upper boundary. If the price goes above the chart range, then I called the direction wrong and will take a loss.

Bear call spread, short the $37 calls and long the $38 calls
sold for a credit and expiring Jan. 24
Probability of expiring out-of-the-money

The proposed trade has a 7:3 risk/reward ratio and with the premium protects all of the chart range while leaving the top 85 cents of the one standard deviation range with less than full profit.



SLB's standard deviation stands at 43%, in the 76th percentile of the rise fro m26% on Novl 24, 2014 to the 48% peak on Dec. 12, 2014.

The one standard deviation rage suggests a potential gain or loss of 6.3%, and the two standard deviation range, of 12.7%.

SLB then, while at a lower relative percentile, is significantly more volatile than INTC.

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

SLB on the chart has been in a clear downtrend since July 1, 2014. For the range, i've chosen the last major peak as the upper boundary. Given the clarity of the trend, the minor bumps afterward seem insignificant to my eye.

A move above that boundary, $88.38, would signify a clear reversal of the trend; levels below that, would not.

Click on chart to enlarge.
SLB 10:20 a.m. New York time,  180 days 4-hour bars

The Trade

My interpretation means that the chart range covers more real estate than does the one standard deviation range, or even the two standard deviation range. In constructing a range, I'll target the lower one standard deviation range as being the most significant, since the chart range would provide insufficient premium to make the trade worthwhile.

In order to get a better premium I've used the JAN5 series, expiring Jan. 31, for the trade.

Bear call spread, short the $83 calls and long the $84 calls
sold for a credit and expiring Jan. 31
Probability of expiring out-of-the-money

The risk reward ratio is 19:6, close to 3:1. The trade covers all of the one standard deviation range, and indeed 34 cents above it. However, it leaves $5.18 of the chart range uncovered.

Decision for My Account

The argument against the INTC trade is inability to determine whether the decline is a countertrend move within a rising stock or the beginning of a downtrend. The near-term bearishness of the general market plays a big role in swinging the argument in favor of a bear play on INTC. I have opened the position, structured as described above.

SLB, by contrast, is an exercise in clarity. The large portion of the chart range left outside of full profitability is an argument against the trade. The strength of the downtrend argues in favor of making the play. I didn't mark it on the chart, but I'll note that a two-day reversal a week ago produced an $83.37 peak on Jan. 9. If I take that lower level as the chart range upper boundary, then only 17 cents is left unprotected. I have opened a position in SLB as described above.

-- Tim Bovee, Portland, Oregon, Jan. 15, 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.

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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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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