Thursday, March 5, 2015

FL: Bear play, volatility rules

The athletic shoe retailer Foot Locker Inc. (FL), headquartered in New York, publishes earnings on Friday, March 6, prior to the opening bell.

FL has no Weeklys among its options inventories, and I shall trade the monthy MAR series of options, which trades for the last time on March 19, 15 days hence.

[FL in Wikipedia]


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.


FL attained a major peak of $59.19 in November 2014 and moved into a so-far small downtrend to the downside. The present rise, beginning in January, has come closest to challenging that peak.

So while the picture from mid-January appears to be quite bullish, it is a desperate sort of bull, pawing the ground and snorting as it tries to escape the roaring bear.

Click on chart to enlarge.
FL at 9:55 a.m. New York time, 180 days 4-hour bars
Implied volatility stands at 36%, in the 92nd percentile of the most recent rise.

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 Trade

FL lacks Weeklys in its options inventory, so the trade must be constructed using the monthly MAR series. The later expiration lengthens the potential lifespan of the position by a week over what it would be using the current Weeklys series.

Zacks Investment Research is neutral regarding FL, although brokerage analysts bullish, collectively coming down with a 47% enthusiasm rating. The most bullish rating, Strong Buy, has been awarded to FL by 73% of the analysts following the company.

FL was trading lower five days after the most recent earnings announcement. Of the three announcements prior to that one, two produced price increases and one no change.

Overall, despite analyst cheering section, I conclude that my position must provide ample profit protection to the downside while not overly slighting the upside.

Bear call spread, short the $60 calls and long the $65 calls,
sold for a credit and expiring March 20
Probability of expiring out-of-the-money


The risk/reward ratio stands at 6:1, which is higher than I like. The corresponding iron condor, with a $60 strike on the short calls and would produces a 4:1 risk/reward ratio.

Both positions provide about the same profit protection to the upside.

The high ratios are due to the fact that FL's options are spaced $5 apart, which is not uncommon for less liquid shares. FL's average volume is running at 1.7 million shares a day.

Decision for My Account

The risk/reward ratio is too high for my taste, and the extra week of the position's lifespan increases the possibility of an extraneous event, or a simple mass change in trader sentiment, turning the position unprofitable.

For those reasons I am passing on the trade and won't be opening a position in FL today.

-- Tim Bovee, Portland, Oregon, March 5, 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".

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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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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