ANF: Volatility play

Update 3/4/2015: ANF reported sales declines at both ends of its products line, resulting in a large gap to the downside when the market next opened after earning were published. (See the Zacks news report here.)

Shares declined by 14.1% over the one-day lifespan of the position, or a 5,134% annual rate. My options positon produced a 41.4% yield on debit, for a 15,116% annual rate.

This is a textbook example of why iron condors are such a useful trading vehicle. They an allow for a fairly wide coverage, and they produce larger premiums than directional vertical spreads do, widening the zone of profit even further.

In the case of my ANF trade, the lower short of the iron concor was $21, and the total premium was 99 cents per share. That pushed the zone of profit down to $20.01.

The stock was trading at  $20.65 when I closed the position, which gave me a profitable trade, helped along by a 24-percentage-point decline in implied volatility, which produced a more favorable spread for my exit.

Iron condors don't all work out this way, but a trade like is the ideal.

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The clothing retailer Abercrombie & Fitch Co. (ANF), headquartered in New Albany, Ohio, publishes earnings on Tuesday, March 4, prior to the opening bell.

ANF has Weeklys in its options inventories, and I shall trade the MAR1 series of options, which trades for the last time on March 6, three days hence.

[ANF in Wikipedia]

ANF

The goal of my trade 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.

Ranges

ANF has been in a major downtrend since 2011, with the last leg on the 10-year chart having begun in August 2014.

For the very near term, which is what concerns me on this chart, the range is quite narrow, from $23.83 to $24.80, well within the one standard deviation range implied by option pricing.

Click on chart to enlarge.

ANF at 10:25 a.m. New York time, 30 days hourly bars

Implied volatility stands at 71%, in the 94th percentile of the most recent rise.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	25.80	27.36	24.80
Lower	22.70	21.14	23.83
Gain/loss	6.4%	12.8%

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

In constructing the position, I've chosen to give up a bit of the one standard deviation range on the upside in return for greater coverage to the downside. Zacks Investment Research gives ANF a highly bearish rating, as do brokerage analysts and the trend. The chart range is fully covered.

Iron condor short the $25 calls and long the $27 calls,
short the $21 puts and long the $19 puts
sold for a credit and expiring March 7, 2015
Probability of expiring out-of-the-money

MAR1	Strike	%
Upper	25	63
Lower	21	75

The risk/reward ratio stands at 1:1.

Decision for My Account

I've opened an iron condor on ANF as described above.

-- Tim Bovee, Portland, Oregon, March 3, 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.

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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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.