Update 2/26/2015; HPQ's price fell dramatically reporting revenues that missed analyst expectations. The performance was blamed in part on the strength of the U.S. dollar compared to other currencies.
I closed out my position today for a loss. The low price reached today, the lowest since earnings, was $34.09 as of this writing, 5.4% below the lower boundary of the two standard deviations range based on options pricing. That range at the time I opened the position was expected to contain 95% of trades until the options expired.
An outlier is a risk of this style of trading. HPQ produced an outlier, big time. There's no lessons learned to be taken away from this. Statistically, outliers will be more rare than stocks that trade as expected, and if I structure my trades to account for that, then I will profit more often than not.
The results: Shares declined by 12.6% over the two-day lifespan of the position, or a 2,293% annual rate. My options position produced a 186.5% loss on debit, for a -34,034% annual rate.
The computer hardware and software technology company Hewlett-Packard Co. (HPQ), headquartered in Palo Alto, California, publishes earnings on Tuesday, Feb. 24, after the closing bell, and the big box general store chain Target Corp. (TGT), headquartered in Minneapolis, Minnesota, publishes earnings prior to the opening bell on Wednesday, Feb. 25.
Both have Weeklys among their options inventories, and I shall trade the FEB4 series of options, which trades for the last time on Feb. 27, three days hence.
The goal of my trades is to construct a direction-neutral position with a zone of profitability at expiration covering all of the one standard deviation range implied by volatility and options pricing, or the 30-day hourly chart support and resistance range, whichever is wider.
HPQ
Ranges
Click on chart to enlarge.
 |
| HPQ @ 11:45 a.m. New York time, 30 days hourly bars |
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 39.28 | 40.35 | 38.85 |
| Lower | 37.14 | 36.07 | 37.31 |
| Gain/loss | 2.8% | 5.6% |
The Trade
HPQ has risen in price after all of the past four earnings announcements. Analyst opinion and the chart are directionally neutral. I get better risk/reward ratios and higher premiums with directionally neutral iron condor than with a directional short vertical that gives some downside protection. This becomes especially important with expiration so near. So I shall try the iron condor first.
short the $37 puts and long the $36 puts
sold for a credit and expiring Feb. 28
Probability of expiring out-of-the-money
| FEB4 | Strike | % |
|---|---|---|
| Upper | 40 | 78 |
| Lower | 37 | 69 |
The risk/reward ratio stands at 7:2. The proposed position cover all of the one standard deviation and chart ranges.
TGT
Ranges
Click on chart to enlarge.
 |
| TGT at 12:15 p.m. New York time, 30 days hourly bars |
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 78.01 | 40.35 | 77.39 |
| Lower | 74.29 | 79.87 | 74.94 |
| Gain/loss | 0.0% | 0.0% |
The Trade
TGT has risen after half of its earnings announcements of the past year, and fallen after half. The analysts and charts produce a bearish score of -0.2, on a range from -1 to 1. The lack of the clear directional guidance, in combinations with the short period until the options expire, points toward an direction-neutral iron condor.
short the $74 puts and long the $73 puts
sold for a credit and expiring Feb. 28
Probability of expiring out-of-the-money
| FEB4 | Strike | % |
|---|---|---|
| Upper | 78 | 68 |
| Lower | 74 | 70 |
The risk/reward ratio stands at 17:20. The proposed position covers all but a cent of the one standard deviation range and all of the chart range.
Decisions for My Account
I've opened positions in HPQ and TGT as described above.
-- Tim Bovee, Portland, Oregon, Feb. 24, 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".
The directional score is calculated as the sum of the following:
- Zacks rating --The Zacks ratings are translated as follows: 1=2, 2=1, 3=0, 4=-1 and 5=-2.
- Enthusiasm rating --: A single percentage derived from the number of analysts whose opinions are in one of five categories: Strong buy, buy, hold, sell and strong sell.
- Strong buy share -- The percentage of all analysts who rank the stock strong buy. If the share is 60% or greater, the score is 1; if 40% or less, then the score is -1; otherwise, the score is zero.
- Ethusiasm momentum -- The score is 1 if today’s enthusiasm rating is larger than the rating 30 days earlier; otherwise, the score is zero.
- 30-day direction -- The trend that best describes the 30-day chart: 1 for an uptrend, -1 for a downtrend and zero for a sideways trend.
- One-day direction -- The trend that best describes the one-day chart: 1 for an uptrend, -1 for a downtrend and zero for a sideways trend.
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.
Alerts
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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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