Tim Bovee, Private Trader: MU, MON: Volatility plays

Update 1/17/2015: My short options spreads on MU and MON expired out-the-money and so without value, providing maximum profit.

MU: During the 10-day lifespan of the position, shares declined by -13.3%, for a -486.7% annual rate. The options produced a 100% yield on debit, or a 3,650.0% annual rate.

MON: During the 10-day lifespan of the position, shares gained 0.3%, for a +9.0% annual rate. The options produced a 100% yield on debit, or a 3,650.0% annual rate.

The semiconductor manufacturer Micron Technology Inc. (MU), headquartered in Boise, Idaho, publishes earnings after the closing bell on Tuesday, and the agro-tech giant Monsanto Corp. (MON), headquartered in St. Louis, Missouri, and best known of late for its genetically engineered seeds, follows on Wednesday before the opening bell. [MU and MON in Wikipedia]

MU

Volatility

Implied volatility stands at 50%, in the 79th percentile of the rise from Nov. 14, 2014 to the Dec. 15, 2014 peak.

The one standard deviation range implied by options pricing, which is expected to encompass 68.2% of trades in the 10 days from now until the January options expire, provides a potential gain or loss of 7.8%, and the two standard deviation range, covering 95% of trades, a gain or loss of 16.4%.

I anticipate resistance at the the Dec. 16, 2014 low of $32.37 which gives MU room to fall unimpeded by more than 4%.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	36.44	39.21	35.74
Lower	30.92	28.15	32.37

Implied volatility 1 and 2 standard deviations; chart support and resistance

The Trade

MU has been in a downtrend from $35.74 on Dec. 29, 2014 That peak was a lower high in the decline from the Dec. 8, 2014 peak $36.59, a major turning point at a level previously seen in 2002, as the price plummeted after the tech bubble burst.

Click on chart to enlarge.

MU 90 days 4-hour bars

We're at that fortunate period on the calendar when the regular monthly issue, the JAN series of options, is close enough to provide a vehicle for trading. This provides high open interest on all strike prices, giving much flexibility in construction a trade

Bear call spread, short the $36 calls and long the $37 calls sold for a credit and expiring Jan. 16 Probability of expiring out-of-the-money

JAN	Strike	%
	36	78.1

My proposed trade provides maximum profit up to and beyond beyond upside resistance on the chart and over nearly all of the 68.2% range implied by options pricing.

The risk-reward ratio is 4:1.

MON

Volatility

Implied volatility stands at 24%, in the 76th percentile of the rise from Nov. 24, 2014 to the Dec. 16, 2014 peak.

Options pricing implies that the 10 days between now the the January options expiration will provide up to a 4% gain or loss on the 68.2% of trades falling within the one standard deviation range, and a 8.2% gain or loss for the 95% within the two standard deviation range.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	122.56	127.29	122.35
Lower	113.08	108.35	116.43

Implied volatility 1 and 2 standard deviations; chart support and resistance
Upside resistance on the chart stands at a high attained Dec. 23, 2014 and last seen in July of that year. Support to the downside stands at a level reached on Dec. 2 and tested once since then, on Dec. 16, when the price broken below down to $116.20 before withdrawing. The price has approached quite near that level, drawing to within two-tenths of a percent on Monday before pulling back a bit.

The Trade

The trend on MON is less clear than on MU. For MON, the price is in decline, but a time of testing is at hand. The present decline appears to be part of a correction that has moved in three waves so far -- A, B, C -- and the present decline can be analyzed as a final wave that will plummet to the downside.

Click on chart to enlarge.

MON 90 days 4-hour bars

The degree of decline from resistance makes it impossible to provide for a profitable trade all the way up to the peak, and it leaves much of the one standard deviation range uncovered. This makes MON a somewhat riskier trade than MU, despite a better risk/reward ratio.

Bear call spread, short the $120 calls and long the $121 calls sold for a credit and expiring Jan. 16 Probability of expiring out-of-the-money

JAN	Strike	%
	120	69.5

The proposed trade provides a 3.8:1 risk/reward ratio.

Decision for My Account

I've opened position in both accounts, as described above.

-- Tim Bovee, Portland, Oregon, Jan. 6, 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".

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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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.